What is the difference between yields and interest rates?

A:
The main difference between yields and interest rates is that each term refers to different financial instruments. Yield commonly refers to the dividend, interest or return the investor receives from a security like a stock or bond, and is usually reported as an annual figure. Interest rate generally refers to the interest charged by a lender such as a bank on a loan, and is typically expressed as an annual percentage rate (APR).

For example, if PepsiCo pays a quarterly dividend of 50 cents and the stock price is $50, then the annual dividend yield would be 4% [(50 cents x 4 quarters) / ($50)]. Therefore the current yield is 4%. If the stock price increases to $100 and the dividend remains the same, then the yield becomes 2%. (Bond yield is a bit more complex - if you want to learn about it take a look at our tutorial: Bond Basics: Yield, Price And Other Confusion.)

As an example of interest rates, suppose you go into your bank to borrow $1000 for a new bicycle and the bank quotes you a 5% interest rate on your loan. If you borrow this amount for one year, the interest you would pay on top of paying back the $1000 would be $50 (simple interest: $1000 x 0.05). If the interest rate is compounded then the interest rate you will pay would be a little bit more. Lenders charge interest to compensate for the opportunity cost of not being able to invest it somewhere else