The yield trick

Many deposit-taking companies are pulling a fast one about the ‘yields’ they offer in order to attract investors. For instance, DHFL which offers an interest rate of 8 per cent per annum on 120-month cumulative deposits compounded half-yearly, claims that the yield is 11.91 per cent, when it’s actually 8.16 per cent. Others such as Shriram Transport Finance Company, Mahindra Finance, PNB Housing Finance and Sundaram BNP Paribas Home Finance also claim higher yields. What gives?

They calculate the yields using the simple interest formula. But that’s the wrong way to arrive at the number. Yield, going by Finance 101, should be calculated using the formula for compound interest. In a cumulative deposit, interest earned is reinvested and, in turn, earns interest in the subsequent period. These periodic additions to the capital need to be considered while calculating yield. The compound interest formula does that, the simple interest one does not. Not just that, there are companies such as SREI Equipment Finance that advertise yields even on non-cumulative deposits where interest is being paid at regular intervals. This goes against the concept of yield which is typically associated only with cumulative investments that benefit from compounding.

Advertising inflated yields or yields on non-cumulative investments is mis-selling, especially in a low-interest environment, when fixed income investors are desperately searching for safe investments and good returns. It’s time the RBI and SEBI cracked the whip and specified the when and how of calculating yields, ensured that deposit-takers toed the line and withdrew misleading claims. Until then, it is ‘buyer beware’. Check and calculate if the number is right with the help of online calculators or the financial functions in MS-Excel.

Senior Assistant Editor

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