Chapter 1
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1. Components of Return
 •Current income:
 –dividends
 (stocks)
 –interest
 (bonds)
 –rent (real
 estate)
 •Capital Gain (Loss):
 –change in
 market value

1. Total Return
 o The sum of the current income and the capital
 gain
 o (or loss) earned on an investment over a
 specified period of time.” Dividend income + cap gain or loss
 o •Total dollar return is the return on an
 investment measured in dollars, accounting
 for all interim cash flows
 and capital gains or losses

Total Return %
•TR(%) = (I + (EV – BV)) ÷ BV
•I ÷ BV = ???
•I ÷ BV = Dividend Yield
•(EV – BV) ÷ BV = ???
•(EV – BV) ÷ BV = Capital Gain
Yield
 •Total Return = Dividend Yield
 +Capital Gain yield

percent return
 • is the return on an
 investment measured as a percentage of the
 ·
 original investment.The
 total percent return is the return for each
 ·
 = Divident Yield +
 Capital Gains Yield
 or TDR/ Beginning Stock
 Price

1. Dividend Yield
Dividend/Share Price

1. Capital Gain
End price Beg Price /beg price

Annualizing Return
 1 + EAR = (1 + holding period percentage return)m
 m = the number of holding periods in a year.
 • In this example, m = 4 (12 months / 3 months). Therefore:
 1 + EAR = (1 + .0556)4 = 1.2416.
 So, EAR = .2416 or
 24.16%.

Risk Premium
The extra return on a risky asset over the riskfree rate; i.e., the reward forbearing risk.

RiskFree Rate
The rate of return on a riskless investment

1. arithmetic average
 o The arithmetic average tells you what youo earned in a typical year
 •For the purpose of forecasting future returns –The arithmetic average isprobably "too high" for long forecasts

geometric average
average compound return earnedper year over a multiyear period–The geometric average isprobably "too low" for short forecasts. geometric average return= sqrt(1+R1)*(1+R2)*...(1+Rn))^(1/n)  1

1. Risk and Return
 o •The riskfree rate represents compensation forjust waiting
 •Therefore, this is often called the time valueof money.o •First Lesson: If we are willing to bear risk, then we can expect to earn arisk premium, at least on average.o •Second Lesson: Further, the more risk we are willing to bear, the greatero the expected risk premium.