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Unformatted text preview: Return On Investment (ROI) • After the fact, actual investment returns can be measured by calculating the Return on Investment , or ROI , an annual measure . • The ROI includes: ▫ Income à Cash received. ▫ Capital Gain/Loss à The change in the value of the asset. • It can be expressed in dollars or percentages. Dollar Profits & Percentage Returns • Dollar Profit or Loss = Ending value + Distributions – Original Cost • Rate of Return = Dollar Profit or Loss Original Cost ▫ Example: You took a $3,700 position in a stock. (100 shares @ $37/share) ▫ The stock paid a $1.85/share dividend during the year and is worth $40.33 one year later. What is your ROI? ▫ Income: $1.85 × 100 shares = $185 ▫ Capital Gain: ($40.33-$37.00) × 100 = $333 ▫ Total Dollar ROI: $185 + $333 = $518 Percentage ROI - Stock • To compare investments, percentages are used. Percentages allow you to compare relative returns. • Dividend Yield = D t +1 / P t • Capital Gain/Loss Yield = (P t +1- P t ) / P t • Total ROI = [ (P t +1- P t ) + D t +1 ] / P t ▫ Where: P t = Stock price at beginning of year D t +1 = Dividend paid during year • Example: You took a $3,700 position in a stock. 100 shares @ $37.00/share; $1.85/share dividend; $40.33/share one year later • Dividend Yield = D t +1 / P t • = $1.85/$37.00 = .05 = 5% • Capital Gain/Loss Yield = (P t +1- P t ) / P t • = ($40.33-$37.00)/$37.00 = 9% • Total ROI = [ (P t +1- P t ) + D t +1 ] / P t • = [($40.33-$37.00) + $1.85] / $37.00 = 14% • Or, = 5% + 9% = 14% Or, = ($4,218 - $3,700) / $3,700 = 14% Risk • We know that the higher the risk, the higher the return expected by investors. ▫ This is called the risk-return tradeoff . ▫ Investors wish to maximize their expected return for a given level of risk…or, minimize their risk for a given expected return. ▫ Risk can be defined as a measure of the uncertainty in a set of potential outcomes for an event in which there is a chance of some loss. ▫ Risk can be quantified by measuring the deviations of the actual returns from the average. ▫ We can statistically quantify risk by calculating the variance and its square root, the standard deviation ( σ )....
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This note was uploaded on 11/06/2011 for the course FIN 3100 taught by Professor Gillette during the Fall '08 term at Kennesaw.
- Fall '08
- Return On Investment (ROI)