When you are evaluating alternative investments for inclusion in your portfolio, you will often be comparing investments with widely different prices or lives. As an example, you might want to compare a $15 stock that pays no dividends to a stock selling for $250 that pays dividends of $10 a year. To properly evaluate these two investments, you must accurately compare their historical rates of returns. A proper measurement of the rates of return is the purpose of this section.
If you commit $200 to an investment at the beginning of the year and you get back $220 at the end of the year, what is your return for the period? The period during which you own an investment is called its holding period, and the return for that period is the holding period return (HPR). In this example, the HPR is 1.10, calculated as follows:
Investment can be defined as the current commitment of dollars for a period of time in order to derive future payments that will compensate the investor for (i) the time the funds are committed, (ii) the expected rate of inflation during this time period, and (iii) the uncertainty of the future payments. The “investor” can be an individual, a government, a pension fund, or a corporation. Similarly, this definition includes all types of investments, including investments by corporations in plant and equipment and investments by individuals in stocks, bonds, commodities, or real estate. This text emphasizes investments by individual investors. In all cases, the investor is trading a known dollar amount today for some expected future stream of payments that will be greater than the current dollar amount today.
Hence, the question is why people invest and what they want from their investments. They invest to earn a return from savings due to their deferred consumption. They want a rate of return that compensates them for the time period of the investment, the expected rate of inflation, and the uncertainty of the future cash flows. This return, the investor’s required rate of return, is discussed throughout this book. A central question of this book is how investors select investments that will give them their required rates of return.
A n investor would be willing to forgo current consumption in order to increase future consumption at a rate of exchange called the risk-fr...
.png)
.png)
.png)
.png)
.png)
.png)
.png)
.png)
.png)
.png)