Annual Percentage Yield
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Annual Percentage Yield
What is Annual Percentage Yield(APY)?
Annual Percentage Yield is the effective annual rate of return earned on a savings account, certificate of deposit(CD), or other interest-bearing account, including the effect of compound interest.
APY offers a more comprehensive view of an account’s earning potential than looking at the nominal interest rate alone. APY includes the effects of compounding, which can be helpful when making comparisons between interest-bearing accounts.
How Do You Calculate the APY?
The standard formula for calculating APY is:
| APY = (1 + r/n)ⁿ − 1 |
Where,
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- r= the nominal annual interest rate, as a decimal
- n = the number of compounding periods per year
APY Calculation Example
Let’s assume that there is a business that invested $10,000 in an account providing a 5% annual interest rate compounded monthly. In this case, using the APY formula, we can find out that APY will be around 5.12%. This means the business would earn approximately $512 in interest over one year, assuming the rate and balance remain unchanged.
Why does APY matter?
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- True comparison capability: Thanks to the consideration of compounding, APY allows comparing an interest-paying account that compounds interest daily with a certificate of deposit that compounds monthly on equal terms.
- Provides the real rate of return: APY reveals what you would earn (or, if it comes to business treasuries that are holding idle cash, what a company would earn) in reality, not just the narrow perspective provided by a nominal interest rate.
- Helpful in cash management: For startups and small businesses that are keeping cash generated from their operations in interest-bearing accounts, APY comparison between different banks or money market funds can have a significant impact on the return on this cash throughout a year.
- Does not take into account the fees: APY is only interest, so it’s worth checking account fees separately, as they can negate the advertised yield.
How Do Companies Optimize for APY?
- Evaluate APY rather than nominal interest rate.
- Take into account the number of compounding periods.
- Evaluate account fees and minimum balance requirements.
- Evaluate whether extra operating cash can be held in proper interest-earning accounts.
- Periodically evaluate interest rates according to market changes.
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