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Unformatted text preview: CHAPTER 4Components of Return:Current I ncome: usually cash or nearcash that is periodically received as a result of owning an investment.Capital Gains (Losses): the change, if any, in the market value of an investment.Real, RiskF ree, & Required Returns:Required Return:rate of return an investor must earn to compensate for the risk taken.Required Return = Real Rate + Expected Inflation Premium + Risk Premiumrj= r*+ IP + RPjReal Rate:rate of return that could be earned in a perfect world where all outcomes are known and certain (where there is no risk.Expected I nflation Premium:the average inflation rate expected in the future.RiskFree Rate: the rate of return that can be earned on a riskfree investment.Risk Free Rate = Real Return + Expected Inflation PremiumRf= r*+ IPRisk Premium:return premium that reflects the issue and issuer characteristics within a given investment vehicle.Holding Period Return: total return earned from holding an investment for a specified period of time. (HPR fails to consider the time value of money).HPR = (Current Income during period + Capital Gains (losses) during period) / Beginning Investment ValueHPT = (C + CG) / VwhereCapital Gains (losses) = Ending Investment value Beginning Investment ValueCG = Vn VRealized Return:current income actually received by an investor.Paper Return:a return that has been achieved but not yet realized by an investor.Yield: The Internal Rate of Return: the compound annual rate of return earned by a longterm investment; the discount rate the produces a present value of the investments benefits that just equals its cost.Yield for a Single Cash Flow:Some investments (savings bonds, stocks w/t dividends, futures contracts, etc.), are purchased for a fixed amount up front, and pays no periodic income, only a single future cash flow at maturity for those investments we can use the IRR yield.On Calculator: treat the earliest value as the PV, the latest value as the FV, and the number of periods holding the investment input the values into the TVM calculator and calculate I /Y. Yield for a Stream of I ncome:Most investments provide streams of income, not a lump sum upon maturity for those investments we can use the IRR yield.On Calculator: cost of investment, cash outflow PV; income expected each period FV; CPT I /Y.Finding Growth Rates: compound annual rate of change in the value of a stream of income. On Calculator: earliest value PV; latest value FV; periods N; CPT I / YTypes of Risk: Business Risk: degree of uncertainty associated with an investments earnings and the investments ability to pay the returns owed to investors....
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This note was uploaded on 12/07/2009 for the course FIRE 314 taught by Professor Upton during the Spring '09 term at VCU.
 Spring '09
 Upton

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