Annual Percentage Yield (APY) is the rate of interest that is earned when taking into consideration the effect of compounding. In Finance, APY is used when referring to the rate paid by a financial institution to a customer while the Annual Percentage Rate (APR) is used when referring to the rate paid by the customer to the financial Constitution.
EXAMPLE
A customer is considering whether to invest in a one-year zero-coupon bond that pays 12% upon maturity or a high-yield money market account that pays 1% per month with monthly compounding. At first glance, the yields appear equal because 12 months multiplied by 1% equals 12%. However, when the effects of compounding are included by calculating the APY, the second investment actually yields 12.7%, as 1.01^12-1 = 0.127.