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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:▫IncomeàCash received. ▫Capital Gain/Loss àThe 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 LossOriginal 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= $518Percentage ROI - Stock•To compare investments, percentages are used. Percentages allow you to compare relativereturns.•Dividend Yield = Dt+1/ Pt•Capital Gain/Loss Yield = (Pt+1- Pt) / Pt•Total ROI = [(Pt+1- Pt) + Dt+1] / Pt▫Where:Pt= Stock price at beginning of yearDt+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 = 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%
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 uncertaintyin 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 returnsfrom the average.▫We can statistically quantify risk by calculating the varianceand its square root, the standard deviation (σ).•The σis the average deviation from the mean.It measures how much the returns can vary (uncertainty).