Risk and Return

Rates of Return

Return comes in two forms: (1) a dividend or interest payment, and (2) a capital gain or capital loss.

For eg. You buy the stock of ABB at the beginning of 2003 when its price was about Rs. 250. By the end of the year the price appreciated to Rs 500 a share. In addition ABB paid a dividend of Rs 2.20 per share

The percentage return on your investment was therefore: Percentage Return = (capital gain + dividend)/ initial share price

= (250+2.2) / 250 = 100.88 %

1

14.94

44.18

2350.89

100

1000Treasury billsLong term treasury bondsCommon stocks (S & P 500)

1925 1999

Portfolio Average Annual Rate of Return

Average Risk Premium (Extra return versus Treasury Bills)

Treasury Bills 3.8

Treasury bonds 5.7 1.9

Common stocks 13.2 9.4

Maturity premium: The difference between Long term government bonds and treasury billsMarket risk premium: Difference between rate of return on common stock and interest rate on treasury bills

Rate of return on = interest rate on + market common stocks Treasury bills risk premium

Measuring risk

• Normal distribution• Standard deviation• Variance