Rate of Return on Securities
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

The rate of return on a security is a major factor associated with evaluating and selecting an investment.  All security-pricing models involve computing the present values of future cash flows the security is expected to pay.  For common stocks, cash flows represent periodic cash dividends.  For bonds, cash flows represent periodic coupon payments plus the face value of the bond at maturity.

Various methods are available for computing the rate of return on a security.  The single-period rate of return is one such measure.  This rate is the percentage price appreciation plus the percentage cash return (current yield on a bond; dividend yield on a stock) during a given period.  The rate is typically expressed as an annualized value.  The single-period rate of return can be computed using the following equation:

 Single- Period   Return = Percentage    price  appreciation + Percentage cash return

 R1 = P1-P1-1 + C1 P1-1 P1-1

Where

R1         =          Return during the period ending at date,
P          =          Security price at date,
P,-1      =          Security price at date,
C,         =          Cash flow received at date,

The equation can also be used to measure future expected single-period returns.  The symbol "E" is used to mean expected return, price, etc.  The following data can be used to illustrate the computation of the actual rate of return on a stock and the expected rate of return on the stock:

#### Stock

P0

C1

P1

E(C2)

E(P2)

Last year's closing price

This year's cash flow

Today's closing price

Next year's expected cash flow

Next year's expected closing price

\$20.000

R  1.00 dividend

\$18.00

\$  1.00 dividend

\$22,00

Last year's actual rate of return on the stock:

 R1 on stock       = \$18-20 + \$1 =    -5.00% \$20 \$20

Expected returns for the coming year would be:

 E(R2) on stock   = \$22-\$18 + \$1 =    +27.8% \$18 \$18

## BIBLIOGRAPHY

BERNSTEIN, LEOPOLD A., Financial Statement Analysis, Irwin, Homewood , IL., 1983.
COLEMAN, ALMAND, et al., Financial Accounting and Statement Analysis:  A Manager's Guide, Robert F. Dame,
Richmond , VA. , 1982.

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