Nominal yield refers to the rate at which the amount of money in any investment increases. For example, let us assume that 100 bonds are purchased on date A for $100,000 ($1,000 per bond). The bonds mature in one year (on date B) with a yield of 7%.
The yield means that the amount of money invested when purchasing the bonds on Date A increases by 7%. The investor will have $107,000 at the end of the year. How much this $107,000 can buy is a separate question.
Real yield refers to the rate at which purchasing power increases during the course of an investment. In the previous example, let us assume that the Consumer Price Index rose 5% during the year, and the price of refrigerators increased at the same rate.
The price of a refrigerator on Date A was $1,000, and its price on Date B was $1,050. At the beginning of the year (date A), 100 refrigerators could be purchased for $100,000. Only 102 refrigerators could be purchased at the end of the year since although the investor will have $107,000, the price of refrigerators has risen to $1,050.
The investor’s purchasing power increased by only 2%, i.e., the annualized real yield. Real yield takes into account the increase in prices during the period: