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Unformatted text preview: Reinvesting dividends 1 Suppose you purchase 1 share of stock for a price P = $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....
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