# FIN CH 8 study guide - Return On Investment (ROI) After the...

• Notes
• MajorFreedomWasp8347
• 7
• 100% (1) 1 out of 1 people found this document helpful

This preview shows page 1 - 3 out of 7 pages.

Return On Investment (ROI)After the fact, actual investment returns can be measured by calculating theReturn onInvestment, orROI, an annual measure.The ROI includes:IncomeàCash received.Capital Gain/LossàThe change in the value of the asset.It can be expressed in dollars or percentages.Dollar Profits & Percentage ReturnsDollar Profit or Loss=Ending value+ Distributions– Original CostRate of Return=Dollar Profit or LossOriginal CostExample: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 oneyear later.What is your ROI?Income: \$1.85 × 100 shares= \$185Capital Gain: (\$40.33-\$37.00) × 100 = \$333Total Dollar ROI: \$185 + \$333= \$518Percentage ROI - StockTo compare investments, percentages are used. Percentages allow you to comparerelativereturns.Dividend Yield=Dt+1/ PtCapital Gain/Loss Yield=(Pt+1-Pt) / PtTotal ROI= [(Pt+1-Pt) + Dt+1] / PtWhere:Pt=Stock price at beginning of yearDt+1=Dividend paid during yearExample:You took a \$3,700 position in a stock. 100 shares @ \$37.00/share; \$1.85/sharedividend; \$40.33/share one year laterDividend Yield =Dt+1/ Pt= \$1.85/\$37.00 = .05 =5%Capital Gain/Loss Yield =(Pt+1-Pt) / Pt= (\$40.33-\$37.00)/\$37.00 =9%Total ROI = [(Pt+1-Pt) + Dt+1] / Pt= [(\$40.33-\$37.00) + \$1.85] / \$37.00 =14%Or, = 5% + 9% = 14%Or, = (\$4,218 - \$3,700) / \$3,700 = 14%
RiskWe know that the higher the risk, the higher the return expected by investors.This is called therisk-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 theuncertaintyin a set of potentialoutcomes for an event in which there is a chance of some loss.Risk can be quantified by measuring the deviations of the actual returnsfrom theaverage.We can statistically quantify risk by calculating thevarianceand its square root,thestandard deviation(σ).Theσis the average deviation from the mean.It measures how much the returns can vary (uncertainty).

Course Hero member to access this document