Definition of wealth
Wealth derives from the old English word "weal". The term was originally an adjective to describe the possession of great qualities.
Adam Smith, in his seminal work The Wealth of Nations, described wealth as "the annual produce of the land and labour of the society". This "produce" is, at its simplest, that which satisfies human needs and wants of utility. In popular usage, wealth can be described as an abundance of items of economic value, or the state of controlling or possessing such items, usually in the form of money, real estate and personal property. An individual who is considered wealthy, affluent, or rich is someone who has accumulated substantial wealth relative to others in their society or reference group. In economics, net wealth refers to the value of assets owned minus the value of liabilities owed at a point in time.[citation needed] Wealth can be categorized into three principal categories: personal property, including homes or automobiles; monetary savings, such as the accumulation of past income; and the capital wealth of income producing assets, including real estate, stocks, and bonds.[citation needed] All these delineations make wealth an especially important part of social stratification. Wealth provides a type of safety net of protection against an unforeseen decline in one’s living standard in the event of job loss or other emergency and can be transformed into home ownership, business ownership, or even a
college education. [1][not in citation given]
'Wealth' refers to some accumulation of resources, whether abundant or not. 'Richness' refers to an abundance of such resources. A wealthy (or rich) individual, community, or nation thus has
more resources than a poor one. Richness can also refer at least basic needs being met with abundance widely shared. The opposite of wealth is destitution. The opposite of richness is poverty.
The term implies a social contract on establishing and maintaining ownership in relation to such items which can be invoked with little or no effort and expense on the part of the owner (see
means of protection).
The concept of wealth is relative and not only varies between societies, but will often vary between different sections or regions in the same society. A personal net worth of US $10,000 in most parts of the United States would certainly not place a person among the wealthiest citizens of that locale. However, such an amount would constitute an extraordinary amount of wealth in
impoverished developing countries.
Concepts of wealth also vary across time. Modern labor-saving inventions and the development of the sciences have enabled the poorest sectors of today's society to enjoy a standard of living
equivalent if not superior to the wealthy of the not-too-distant past. This comparative wealth across time is also applicable to the future; given this trend of human advancement, it is likely that the standard of living that the wealthiest today enjoy will be considered rude poverty by future generations.
Some of the wealthiest countries in the world are the United States, the United Kingdom, the Republic of Ireland, Norway, Japan, Kuwait, United Arab Emirates, South Korea, Germany, The
Netherlands, Belgium, France, Israel, Taiwan, Australia, Singapore, Philippines, Canada, Finland, Greece, Spain, Portugal, Sweden, Italy, Denmark, New Zealand, Iceland, Monaco,
Luxembourg, Liechenstein and Switzerland, the larger of which are in the G8. All of the above countries, except United Arab Emirates and Kuwait, are considered developed countries.
Anthropological views
Anthropology characterizes societies, in part, based on a society's concept of wealth, and the institutional structures and power used to protect this wealth. Several types are defined below. They can be viewed as an evolutionary progression. Many young adolescents have become wealthy from the inheritance of their families.
The interpersonal concept
Early hominids seem to have started with incipient ideas of wealth[citation needed], similar to that of the great apes. But as tools, clothing, and other mobile infrastructural capital became
important to survival (especially in hostile biomes), ideas such as the inheritance of wealth, political positions, leadership, and ability to control group movements (to perhaps reinforce such
power) emerged. Neandertal societies had pooled funerary rites and cave painting which implies at least a notion of shared assets that could be spent for social purposes, or preserved for
social purposes. Wealth may have been collective.
Accumulation of non-necessities
Humans back to and including the Cro-Magnons seem to have had clearly defined rulers and status hierarchies. Digs in Russia have revealed elaborate funeral clothing on a pair of children
buried there over 35,000 years ago.[citation needed] This indicates a considerable accumulation of wealth by some individuals or families. The high artisan skill also suggest the capacity to
direct specialized labor to tasks that are not of any obvious utility to the group's survival.
Control of arable land
The rise of irrigation and urbanization, especially in ancient Sumer and later Egypt, unified the ideas of wealth and control of land and agriculture.[citation needed] To feed a large stable
population, it was possible and necessary to achieve universal cultivation and city-state protection. The notion of the state and the notion of war are said to have emerged at this time. Tribal cultures were formalized into what we would call feudal systems, and many rights and obligations were assumed by the monarchy and related aristocracy. Protection of infrastructural capital built up over generations became critical: city walls, irrigation systems, sewage systems, aqueducts, buildings, all impossible to replace within a single generation, and thus a matter of social survival to maintain. The social capital of entire societies was often defined in terms of its relation to infrastructural capital (e.g. castles or forts or an allied monastery, cathedral or temple), and natural capital, (i.e. the land that supplied locally grown food). Agricultural economics continues these traditions in the analyses of modern agricultural policy and related ideas of wealth, e.g. the ark of taste model of agricultural wealth.
The capitalist notion
Banknotes from all around the world donated by visitors to the British Museum, London. Industrialization emphasized the role of technology. Many jobs were automated. Machines replaced some workers while other workers became more specialized. Labour specialization became critical to economic success. However, physical capital, as it came to be known, consisting of both the natural capital (raw materials from nature) and the infrastructural capital (facilitating technology), became the focus of the analysis of wealth. Adam Smith saw wealth creation as the
combination of materials, labour, land, and technology in such a way as to capture a profit (excess above the cost of production).[2] The theories of David Ricardo, John Locke, John Stuart Mill, and later, Karl Marx, in the 18th century and 19th century built on these views of wealth that we now call classical economics and Marxian economics (see labor theory of value). Marx
distinguishes in the Grundrisse between material wealth and human wealth, defining human wealth as "wealth in human relations"; land and labour were the source of all material wealth.
Sociological view
“Wealth provides an important mechanism of the intergenerational transmission of inequality.”[3] Approximately half of the wealthiest people in America inherited family fortunes. But the effect of inherited wealth can be seen on a more modest level as well. For example, a couple that buys a house with the financial help from their parents or a student that has his or her college education paid for, are benefiting directly from the accumulated wealth of previous generations. [4]
As a result of different conditions of life, members of different social classes view the world in many different ways. This allows them to develop different “conceptions of social reality, different aspirations and hopes and fears, different conceptions of the desirable.” [5] The way different classes in society view wealth vary and these diverse characteristics are a fundamental dividing line among the classes. Today there is an extremely skewed concentration of wealth in America, more so than even income. [6] In 1996 the Fed survey reported that the net worth of the top 1 percent was approximately equal to that of the bottom 90 percent. [7]
The upper class
Inheritance establishes different starting lines. The majority of those in the upper class have inherited their wealth and place a greater emphasis on wealth than on income. Upper class
children are taught about investments and accumulation. They are trained and conditioned, technically and philosophically, to handle the wealth that they will inherit and how to earn more
later in life. Wealth and being a member of the upper class requires significant prior preparation and familiarization. If not trained correctly children may easily squander immense wealth,
though this rarely happens. They use the power and freedom that comes with wealth to leverage opportunities. This allows them more flexibility in their lives and as a result have fewer worries.
[8]
The accumulation of wealth fosters a growth of power, which in turn creates privileges conducive to more wealth. Children of the upper class are socialized on how to manage this power and
channel this privilege in many different forms such as gaining access to other’s capital and to critical information. It is by accessing various edifices of information, associates, procedures and
auspicious rules that the upper class are able to maintain their wealth and pass it along, and not necessarily because of an extreme work ethic. [9]
The middle class
There is a distinct difference in views about wealth among the middle class compared to those of the upper class. Where the upper class beliefs focus on wealth, the middle class places a
greater emphasis on income. The middle class views wealth as something for emergencies and it is seen as more of a cushion. This class is comprised of people that were raised with families
that typically owned their own home, planned ahead and stressed the importance of education and achievement. They earn a significant amount of income and also have significant amounts
of consumption. However there is very limited savings (deferred consumption) or investments, besides retirement pensions and homeownership. They have been socialized to accumulate
wealth through structured, institutionalized arrangements. Without this set structure, asset accumulation would likely not occur. [10]
The working class
The working class has fewer options for advancement and wealth accumulation than the upper and middle classes. This can be characterized as having limited income, unstable employment
and an insignificant retirement pension account. Access to structured asset accumulation programs, such as retirement pensions, are not readily available to those in this class and as a result little of their earnings are actually saved or invested. Consequently, there is a limited financial cushion available in times of hardship such as a divorce or major illness. Just as their parents, children who lack assets are less likely to plan for the future. [11]
The welfare class
Those with the least amount of wealth are the welfare poor. Wealth accumulation for this class is to some extent prohibited. People that receive AFDC transfers cannot own more than a trivial
amount of assets, in order to be eligible and remain qualified for income transfers. Most of the institutions that the welfare poor encounter discourage any accumulation of assets. [12]
Other concepts
Global wealth
Michel Foucault commented that the concept of Man as an aggregate did not exist before the 18th century. The shift from the analysis of an individual's wealth to the concept of an
aggregation of all men is implied in the concepts of political economy and then economics. This transition took place as a result of a cultural bias inherent in the Enlightenment. Wealth was
seen as an objective fact of living as a human being in a society.
Not a zero-sum game
Regardless of whether one defines wealth as the sum total of all currency, the M1 money supply, or a broader measure which includes money, securities, and property, the supply of wealth,
while limited, is not fixed. Thus, there is room for people to gain wealth without taking from others, and wealth is not necessarily a zero-sum game, though short-term effects and some
economic situations may make it appear to be so. Many things can affect the creation and destruction of wealth including size of the work force, production efficiency, available resource
endowments, inventions, innovations, and availability of capital.
However, at any given point in time, there is a limited amount of wealth which exists. That is to say, it is fixed in the short term. People who study short term issues see wealth as a zero-sum
game and concentrate on the distribution of wealth, whereas people who study long-term issues see wealth as a non-zero sum game and concentrate on wealth creation. Other people put
equal emphasis on both the creation and the distribution of wealth. It has been theorized, for example, by Robert Wright, among others, that society becomes increasingly non-zero-sum as it
becomes more complex, specialized, and interdependent.
One's attitude towards this issue affects the design of the social or economic system that one prefers.
The non-normative concept
Neoclassical economics tries to be non-normative for the most part, to be objective and free of value statements. If it is successful, then wealth would be defined in such a way that it would not
be preconceived to be either positive or negative. This objective has not always been the case. In prior eras wealth was assumed to be a set of means of persuasion.
It was often seen as self-interested arguments by the powerful explaining why they should remain in power. In The Prince, Niccolò Machiavelli had commented in that earlier era on the
prudent use of wealth, and the need to tolerate some cruelty and vice in the use of it, in order to maintain appearances of strength and power.
Jane Jacobs in the 1960s and 70s offered the observation that there were two different moral syndromes that were common attitudes to wealth and power, and that the one more associated
with guardianship did in fact require a degree of ostentatious conspicuous consumption if only to impress others.
This logic is almost entirely absent from neoclassical economics, which in its extreme form argues for the abolition of any political economy apart from the service markets wherein favours
may be bought and sold at will, including political ones - the so-called political choice theory popular in the U.S.A.. While it is entirely likely that such assumptions apply in the subcultures
that dominate modern discourse on technical economics and especially macroeconomics, the less technical notions of wealth and power that are implied in the older theories of economics and ideas of wealth, still continue as daily facts of life.
Non-financial
The 21st century view is that many definitions of wealth can exist and continue to co-exist. Some people talk about measuring the more general concept of well-being.[who?] This is a difficult
process but many believe it possible - human development theory being devoted to this. Furthermore, Manoj Sharma [1], the head of DifferWorld's [2]faculty makes a very strong case of the importance of factoring in both financial wealth and non-financial wealth as a measure of True Wealth. Manoj Sharma's definition of True Wealth being a combination of financial, mental,
emotional, physical and spiritual wealth; and how it is channeled towards the general good of humanity. Although these alternative measures of wealth exist, they tend to be overshadowed
and influenced by the dominant money supply and banking system. For more on the modern notions of wealth and their interaction see the article on political economy.
Sustainable wealth as a measure of well-being
Sustainable wealth is defined by the author of Creating Sustainable Wealth, Elizabeth M Parker, as meeting the individual’s personal, social and environmental needs without compromising
the ability of future generations to meet their own needs. This definition of sustainable wealth comes from the marriage of sustainability as defined by the Brundtland Commission and wealth
defined as a measure of well-being, not only from marriage but it also can be earned by working hard.
Sustainable wealth
According to the author of Wealth Odyssey, Larry R. Frank Sr, wealth is what sustains you when you are not working. It is net worth, not income, which is important when you retire or are unable to work (premature loss of income due to injury or illness is actually a risk management issue). The key question is how long would a certain wealth last? Ongoing withdrawal research has sustainable withdrawal rates anywhere between approximately 3 percent and 8 percent, depending on the research’s assumptions. Time, how long wealth might last, then becomes a function of how many times does the percentage withdrawal rate go into all the assets. Example: withdrawing 3 percent a year into 100 percent equals 33.3 years; 4 percent equals 25 years; 8 percent equals 12.5 years, etc. This ignores any growth, which presumably would be used to offset the effects of inflation. Growth greater than the withdrawal rate would extend the time assets may last, while negative growth would reduce the time assets may last. Clearly a lower withdrawal rate is more conservative. Knowing this helps you determine how much wealth you need also.
Example: you know you will need $40,000 a year and use a 4 percent withdrawal rate, then you need to use 5 percent and therefore need $800,000, etc. This simple “wealth rule” helps you
estimate both the time and the amount.
Buckminster Fuller's Notion of Wealth
In section 1075.25 of Synergetics, Buckminster Fuller defined wealth as "the measurable degree of established operative advantage." In Critical Path[13] Fuller described his notion as that
which "realistically protected, nurtured, and accommodated X numbers of human lives for Y number of forward days." Philosophically, Fuller viewed "real wealth" as human know-how and
know-what which he pointed out is always increasing.
The limits to wealth creation
There is a debate in economic literature, usually referred to as the limits to growth debate in which the ecological impact of growth and wealth creation is considered. Many of the wealth
creating activities mentioned above (cutting down trees, hunting, farming) have an impact on the environment around us. Sometimes the impact is positive (for example, hunting when herd
populations are high) and sometimes the impact is negative (for example, hunting when herd populations are low).
Most researchers feel that sustained environmental impacts can have an effect on the whole ecosystem. They claim that the accumulated impacts on the ecosystem put a theoretical limit on
the amount of wealth that can be created. They draw on archeology to cite examples of cultures that they claim have disappeared because they grew beyond the ability of their ecosystems to
support them.
Others are more optimistic (or, as the first group might claim, more naïve). They claim that although unrestrained wealth-creating activities may have localized environmental impact, large
scale ecological effects are either minor or non-existent; or that even if global scale ecological effects exist, human ingenuity will always find ways of adapting to them, so that there is no
ecological limit to the amount of growth or wealth that this planet will sustain[citation needed].
More fundamentally, the limited surface of Earth places limits on the space, population and natural resources available to the human race, at least until such time as large-scale space travel
is a realistic proposition.
The difference between income and wealth
Wealth is a stock that can be represented in an accounting balance sheet, meaning that it is a total accumulation over time, that can be seen in a snapshot. Income is a flow, meaning it is a
rate of change, as represented in an Income/Expense or Cashflow Statement. Income represents the increase in wealth (as can be quantified on a Cashflow statement), expenses the decrease
in wealth. If you limit wealth to net worth, then mathematically net income (income minus expenses) can be thought of as the first derivative of wealth, representing the change in wealth over a period of time.
Wealth as measured by time
Wealth has also been defined as "the amount of time an individual can maintain his current lifestyle for, without any new income." For example if a person has $1000, and their lifestyle
dictates $1000 per week of expenses, then their wealth is measured as 1 week. Under this definition, a person with $10,000 of savings and expenses of $1000 per week (10 weeks of wealth) would be considered wealthier than a person with $20,000 of savings and expenses of $5000 per week (4 weeks of wealth).
Distribution
Main article: Distribution of wealth
Capitalism asserts that all wealth is earned, not distributed. It can only be distributed after it is forcibly seized from the earners (usually in the form of tax). Wealth acquired this way is then
distributed. Thus this section is concerned with the anti-capitalist conception of wealth, namely that all wealth is collective and distributed among individuals.
Different societies have different opinions about wealth distribution and about the obligations related to wealth, but from the era of the tribal society to the modern era, there have been means of moderating the acquisition and use of wealth.
In ecologically rich areas such as those inhabited by the Haida in the Cascadia ecoregion, traditions like potlatch kept wealth relatively evenly distributed, requiring leaders to buy continued status and respect with giveaways of wealth to the poorer members of society. Such traditions make what are today often seen as government responsibilities into matters of personal honour.
In modern societies, the tradition of philanthropy exists. Large donations from funds created by wealthy individuals are highly visible, although small contributions by many people also offer a
wide variety of support within a society. The continued existence of organizations which survive on donations indicate that modern Western society has at least some level of philanthropy.
Furthermore, in today's societies, much wealth distribution and redistribution is the result of government policies and programs. Government policies like the progressivity or regressivity of the tax system can redistribute wealth to the poor or the rich respectively. Government programs like “disaster relief” transfer wealth to people that have suffered loss due to a natural disaster. Social security transfers wealth from the young to the old. Fighting a war transfers wealth to certain sectors of society. Public education transfers wealth to families with children in public schools.
Public road construction transfers wealth from people that do not use the roads to those people that do (and to those that build the roads). Certain people resent having to contribute to some or
all of these programs, and disparagingly label them social engineering.
Like all human activities, wealth redistribution cannot achieve 100% efficiency. The act of redistribution itself has certain costs associated with it, due to the necessary maintenance of the
infrastructure that is required to collect the wealth in question and then redistribute it. Different people on different sides of the political spectrum have different views on this issue. Some see it
as unacceptable waste, while others see it as a natural fact of life, which is inevitable in all kinds of inter-human relations.
Proponents of the supply-side theory of "trickle-down" economics claim that it is a form of time-deferred philanthropy. The theory is that newly created wealth eventually "trickles down" to all
strata of society. The argument goes that although wealth is created primarily by the wealthy, they will tend to reinvest their wealth, and this process will create even more wealth. As the
economy grows, it is said that more and more people will share in the newly created wealth. A similar argument can be made in the case of Keynesian economics. According to this theory,
government redistributions and expenditures have a multiplier effect that stimulates the economy and creates wealth. Supply-siders claim that wealth is created primarily by investment (supply), whereas Keynesians claim that wealth is driven by expenditure (demand). Today most economists agree that growth can be stimulated by either the supply or demand side, and some
of them argue that these are really two sides of the same coin, in the sense that you seldom get one without the other. Nevertheless, the dispute between supply-side and Keynesian economics
is of continuing interest.
Stresses within social distribution systems can be understood within a broad theory of political economy, where tradeoffs between means of protection, persuasion and production, and
valuations of different styles of capital, are described. Simply put, if the rich do not at least once in a while give away, of their own free will, at least a small part of their wealth to the poor, then
the poor are much more likely to rebel against the rich.
Wealth in the form of land
Many indigenous cultures, being either nomadic or communitarian in nature, rejected the notion of the private ownership of land wealth. In the western tradition, the concepts of owning land
and accumulating wealth in the form of land were engendered in the rise of the first states, for a primary service and power of government was, and is to this day, the awarding and adjudication of land use rights.
Land ownership was also justified according to John Locke. He claimed that because we admix our labour with the land, we thereby deserve the right to control the use of the land and benefit
from the product of that land (but subject to his Lockean proviso of "at least where there is enough, and as good left in common for others.").
Additionally, in our post-agricultural society this argument has many critics (including those influenced by Georgist and geolibertarian ideas) who argue that since land, by definition, is not a
product of human labor, any claim of private property in it is a form of theft; as David Lloyd George observed, "to prove a legal title to land one must trace it back to the man who stole it."
Many older ideas have resurfaced in the modern notions of ecological stewardship, bioregionalism, natural capital, and ecological economics.
Look up wealth in Wiktionary, the free dictionary.Affluence in the United States
Capital accumulation
Distribution of wealth
Household income in the United States
Income in the United Kingdom
Lists of billionaires
Personal income in the United States
Poverty
Private banking
Surplus product
Value added
Wealth (economics)
Wealth condensation
Wealth and religion
Article in Dow Jones Insight magazine on wealth
References
^ Gilbert, Dennis. The American Class Structure in an Age of Growing Inequality . N.p.: Wadsworth Publishing;, 2002.
^ Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations
^ Gilbert, Dennis. The American Class Structure in an Age of Growing Inequality . N.p.: Wadsworth Publishing;, 2002.
^ Gilbert, Dennis. The American Class Structure in an Age of Growing Inequality . N.p.: Wadsworth Publishing;, 2002.
^ Aspects of Poverty. Ed. Ben B Seligman. New York: Thomas Y. Crowell Company, 1968.
^ Ropers, Richard H, Ph.D. Persistent Poverty: The American Dream Turned Nightmare. New York: Insight Books, 1991.
^ Gilbert, Dennis. The American Class Structure in an Age of Growing Inequality . N.p.: Wadsworth Publishing;, 2002.
^ Smith, Roy C. The Wealth Creators: The Rise of Today's Rich and Super-Rich. New York: Truman Talley Books, 2001.
^ Sherraden, Michael. Assets and the Poor: A New American Welfare Policy. Armonk: M.E. Sharpe, Inc., 1991.
^ Sherraden, Michael. Assets and the Poor: A New American Welfare Policy. Armonk: M.E. Sharpe, Inc., 1991.
^ Sherraden, Michael. Assets and the Poor: A New American Welfare Policy. Armonk: M.E. Sharpe, Inc., 1991.
^ Sherraden, Michael. Assets and the Poor: A New American Welfare Policy. Armonk: M.E. Sharpe, Inc., 1991.
^ Fuller, R. Buckminster (1981). Critical Path. New York: St. Martin's Press. pp.p. 125. ISBN 0312174888.
In economics and business, wealth of a person or nation is the value of assets owned net of liabilities owed (to foreigners in the case of a nation) at a point in time. The assets include those
that are tangible (land and capital) and financial (money, bonds, etc.). Wealth may be measured in nominal or real values. Measurable wealth typically excludes intangible or nonmarketable
assets such as human capital and social capital. In economics, 'wealth' corresponds to the accounting term 'net worth'. But analysis may adapt typical accounting conventions for economic
purposes in social accounting (such as in national accounts). An example of the latter is generational accounting of social security systems to include the present value projected future
outlays considered as liabilities.
Economic terminology distinguishes between two types of variables: a stock and a flow. Wealth, as measurable at a date in time, is a stock, like the value of an orchard on December 31 minus
debt owed on the orchard. For a given amount of wealth, say at the beginning of the year, income from that wealth, as measurable over say a year is a flow. What marks the income as a flow is
its measurement per unit of time, like the value of apples yielded from the orchard per year.
Distribution (economics)
Distribution of wealth
Income, including section Meaning in economics and use in economic theory
National accounts
Wealth effect
Wealth elasticity of demand
References
Robert J. Barro (1974). "Are Government Bonds Net Wealth?," Journal of Political Economy, 8(6), pp. 1095-111.
John Bates Clark (1902). The Distribution of Wealth (analytical Table of Contents).
Laurence J. Kotlikoff, 1987, “social security," The New Palgrave: A Dictionary of Economics, v. 4, pp. 413-18. Stockton Press.
_____, 1992, Generational Accounting. Free Press.
David S. Landes. (1998) The Wealth and Poverty of Nations. Book preview.
Nancy D. Ruggles (1987). "social accounting," The New Palgrave: A Dictionary of Economics, v. 3, pp. 377-82, esp. p. 380.
Paul A. Samuelson and William D. Nordhaus (2004, 18th ed.). Economics, "Glossary of Terms."
Adam Smith (1776). The Wealth of Nations.
Partha Dasgupta (1993). An Inquiry into Well-Being and Destitution. (Pub. description)
Categories: Wealth Macroeconomics Microeconomics National accounts Economic indicators Index numbers Welfare economics Economics terminology Economic term stubs
Source: Wikipedia
Weighted Average Cost of Capital (WACC)
The overall rate of return desired by all investors (stock and bond) in a company:
WACC = [Ke + Kd(D/E)] / [1 + D/E]
where the terms in the formula are defined in this WACC-a-tron:
Ke (desired return on equity):
Kd (desired return on debt):
D/E (debt-to-equity ratio)
Wilshire 5000
Stock index consisting of more than 5000 companies, representing virtually all of the capitalization of the entire U.S. stock market. See the index funds overview, and the website of Wilshire
Associates.
Yield
One of several numbers describing the annual interest rate paid by a bond.
See
coupon
current yield
equivalent yield
yield to call
yield to maturity
Coupon
Annual interest rate paid by a bond, expressed as a percentage of its par value. Compare current yield, yield to maturity.
Current Yield
Annual interest rate paid by a bond, expressed as a percentage of its current market price. Compare coupon, yield to maturity.
Equivalent Yield
Pro-rated annual interest rate paid by a short-term bond, expressed as a percentage of its current market price. (In other words, it's the same as current yield, but for bonds that reach maturity in less than a year).
Yield to Call
A rate of return measuring the performance of a callable bond, from the time of purchase to its call date. Similar to Yield to Maturity, but calculated using the call date instead of the maturity
date, and the call price instead of the par value.
Yield to Maturity (YTM)
A rate of return measuring the total performance of a bond (coupon payments as well as capital gain or loss) from the time of purchase until maturity. See the main article for the formula and
more information
Bond Yield-to-Maturity
Imagine you are interested in buying a bond, at a market price that's different from the bond's par value. There are three numbers commonly used to measure the annual rate of return you are getting on your investment:
Coupon Rate: Annual payout as a percentage of the bond's par value
Current Yield: Annual payout as a percentage of the current market price you'll actually pay
Yield-to-Maturity: Composite rate of return off all payouts, coupon and capital gain (or loss)
(The capital gain or loss is the difference between par value and the price you actually pay.)
The yield-to-maturity is the best measure of the return rate, since it includes all aspects of your investment. To calculate it, we need to satisfy the same condition as with all composite payouts:
Whatever r is, if you use it to calculate the present values of all payouts and then add up these present values, the sum will equal your initial investment.
In an equation,
1. c(1 + r)-1 + c(1 + r)-2 + . . . + c(1 + r)-Y + B(1 + r)-Y = P
where
c = annual coupon payment (in dollars, not a percent)
Y = number of years to maturity
B = par value
P = purchase price
You should try to form a mental picture of what this equation is saying. The left side represents Y+1 different compound interest curves, all starting out now, and each one ending at the
moment that the payout it corresponds to takes place. Most of these curves will lie pretty low to the axis, because they only grow to a value of c, the coupon payment. The very last curve will be
a lot taller, and end up at the par value B. And if you add up the present values of all these curves (that's the left side of the equation), the sum will exactly equal the purchase price of the bond
(that's the right side).
As with most composite payout problems, equation 1 can't be solved exactly, in general. The nice part is that all yield-to-maturity problems have basically the same form, so people have been
able to create programmable calculators and computer programs (and even tables back in the old days) to help you find r.
Example: Suppose your bond is selling for $950, and has a coupon rate of 7%; it matures in 4 years, and the par value is $1000. What is the YTM?
The coupon payment is $70 (that's 7% of $1000), so the equation to satisfy is
2. 70(1 + r)-1 + 70(1 + r)-2 + 70(1 + r)-3 + 70(1 + r)-4 + 1000(1 + r)-4 = 950
Of course you aren't really going to solve this, so you just use the popup calculator instead, and find that r is 8.53%. If you want, you can plug this number back into equation 2, just to make
sure it checks out.
One thing to notice is that the YTM is greater than the current yield, which in turn is greater than the coupon rate. (Current yield is $70/$950 = 7.37%). This will always be true for a bond selling at a discount. In fact, you will always have this:
Bond Selling At . . . Satisfies This Condition
Discount Coupon Rate <> Current Yield > YTM
Par Value Coupon Rate = Current Yield = YTM
Bond Yields and Prices
Once a bond has been issued and it's trading in the bond market, all of its future payouts are determined, and the only thing that varies is its asking price. If you buy such a bond the yield to
maturity you'll get on your investment naturally increases if you can buy it at a lower price: as they say, bond prices and yields "move" in opposite directions. That can be confusing since
people aren't always consistent in the way they talk about bond performance. If somebody says "10 year treasuries were down today", they probably mean that the asking price was down (so it was a bad day for bond holders); but they sometimes mean that the yield to maturity was down because the asking price was up (a good day for bond holders).
Zero Coupon Bond
A bond that sells at a huge discount and pays no interest