What is Yield Advantage?
Yield Advantage is a difference between yields on two different securities issued by the same company. We can also say it is an additional amount expected by investor by choosing one security over other.
Yield Advantage = Yield on Security A – Yield on Security B
Suppose Company ABC has two types of securities outstanding: 10,000,000 shares of common stock that pay $0.50 a year in dividends and $20,000,000 in convertible bonds that pay 7% interest per year (or $70 per $1,000 bond). The bonds are convertible into common stock.
If the stock is trading at $20 per share and the bonds are trading at $1,200 per bond, we first find out the yields on each security:
Stock: $0.50 / $20 = 0.025 or 2.5%
Convertible Bonds: $70 / $1,200 = 0.0583 or 5.83%
Using above formula, we can calculate the yield advantage for the convertible bonds is:
5.83 – 2.5 = 3.33%
Above case reveals that Company ABC investor’s yield is higher on convertible bonds as compare to that on common shares.
Yield advantage helps in evaluation of company’s financial structure decisions. Sometime it also indicates monitoring of a company’s financial structure in an effort to preserve cash.