ReinvestingDividends

# ReinvestingDividends - Reinvesting dividends 1 Suppose you...

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Reinvesting dividends 1 Suppose you purchase 1 share of stock for a price P 0 = \$100. One year from now, the stock pays a dividend D 1 = \$2 and sells for price P 1 = \$106. Two years from now, the stock pays another dividend D 2 = \$2 and sells for price P 2 = \$110 (Note: P 1 and P 2 are the prices just after the dividends are paid). Assuming you reinvested the D 1 in the stock, what is your holding period return over the two years? There are two ways to calculate the holding period return, each giving the same answer: Method 1 Recall the computation from the course pack reading “Geometric Average Versus Arithmetic Average”. In this reading, the holding period return on an investment in a mutual fund was shown to equal HPR = [(1 + R 1 )(1 + R 2 )] 1 / 2 - 1 , where R 1 was the return over the first year and R 2 was the return over the second. In fact, nothing in the example requires R 1 and R 2 to be mutual fund returns. They could be returns on any investment. We can use this same formula to compute the return on holding the stock. The return over the first year of

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