How yields and compounding work

A yield is the return an investment pays, almost always expressed as a percentage per year (ao ano, abbreviated a.a. in Brazil). Understanding how that headline number turns into money is the single most useful skill in fixed income.

Compounding — interest on interest

Fixed income in Brazil compounds: each period’s interest is added to the principal, and the next period earns interest on the larger balance. Over years this snowball effect dominates. A simplified example of a prefixed bond at 10% per year:

Year 0:  1,000.00
Year 1:  1,000.00 x 1.10 = 1,100.00
Year 2:  1,100.00 x 1.10 = 1,210.00
Year 3:  1,210.00 x 1.10 = 1,331.00

Note the third year added 121, not 100 — that extra 21 is interest earned on prior interest.

The reference rates you will see

• Selic — the central bank’s policy rate, the anchor for almost everything.
• CDI — tracks Selic very closely and is the benchmark most private instruments quote against ("% of CDI").
• IPCA — official inflation; inflation-linked bonds add a real rate on top of it.

Reading a quote

• "100% of CDI" — you earn whatever the CDI accumulates over your holding period.
• "Selic + 0.10%" — the Selic accumulation plus a small fixed spread.
• "11% a.a. prefixado" — a flat 11% per year, fixed.
• "IPCA + 6% a.a." — inflation plus a 6% real return.

Nominal versus real

The nominal return is the raw percentage. The real return is what is left after inflation. A prefixed 10% in a year where inflation runs 5% is roughly a 5% real gain. Always think in real terms when judging whether a fixed return actually grows your purchasing power.