What is a yield gap?
Understanding Yield Gap
A difference in yield between two different financial instruments is called a yield gap. It is usually looked at to compare the performance of shares and bonds. It is the difference between the yield on benchmark long-term government bonds and the dividend yield of a share or an index at any given time.
Dividend Yield
A dividend yield indicates the amount of dividend that a company pays each year relative to the market value of the shares.
Bond yield
Bond yield is the return that an investor gets by investing in bonds. The yield is in the form of interest that an investor receives from the bond issuer.
If the 10-year bond has a yield of 6.8% and the dividend yield of the Nifty 50 index is 1.42%, then the yield gap between the two assets is 5.6%.
Checking out who is better?
Investors often use the yield gap to evaluate the relative attractiveness of different investment opportunities. A larger yield gap generally implies that one investment is riskier or less desirable than another and may reflect differences in credit risk, liquidity, or other factors.
Investors may also use yield gap analysis to identify opportunities for arbitrage, where they can profit from price discrepancies between securities with similar characteristics but different yields.
It must be remembered that a yield gap analysis alone cannot form the basis for investing in an asset. Other factors, such as market conditions, company fundamentals, and overall portfolio goals too, must be factored in while making an investment decision.
One should generally use the yield gap when evaluating bonds and shares. The yield gap between stocks and bonds can suggest if the equity market is over or undervalued vis-à-vis bonds.
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