This document discusses different methods for measuring rates of return on investments. It defines total return as the sum of income payments like dividends and capital gains or losses. An example is provided to demonstrate calculating total return, dividend yield, and capital gain yield for a share of Canadian Pacific Railway stock. The document also discusses how to convert nominal return to real return after accounting for inflation. It outlines different types of systematic risks like market risk and interest rate risk that cannot be diversified away, as well as unsystematic risks at the business and financial level that can be diversified.

1. Corporate Finance
Risk & Return

2. Rates of Return: A Review

Measuring Rate of Return

The total return on an investment is made up of:


Income (dividend or interest payments).
Capital gains (or losses).
Percentage Return =
Capital Gain + Dividend
Initial share Price

3. Rates of Return: A Review
Capital Gain Yield =
Dividend Yield =
Capital Gain
Initial Share Price
Dividend
Initial Share Price
1 + nominal rate
1 + real rate =
1 + inflation rate

4. Rates of Return: A Review

An Example:
A Canadian Pacific Railway (CP) share had a value of $61.40 at
the beginning of 2007. By the end of the year, the price went
up to $64.22. In addition, during the year, CP paid a $0.90
dividend per share.
% return = Capital gain+dividend/initial share price
(64.22 – 61.40) + 0.90
= 6.06%
61.40
Dividend yield =
0.90/61.40 = 1.47%
Capital gain yield = 2.82/61.40 = 4.59%
Total return= 1.47% + 4.59% = 6.06%

5. Rates of Return: A Review
 Total




return= 1.47% + 4.59% = 6.06%
This is the nominal return (how much more money you
will have at the end of year if invested today)
To convert from nominal return to real return with
inflation of 4.1% (to find how much more you will be able
to buy with your money at the end of year)
1+real rate of return=1+0.0606/1+0.04
real rate of return=1.019-1= 1.98%

6. Systematic Risk & Unsystematic Risk
Systematic Risk



Market Risk
Interest Rate Risk
Purchasing Power Risk
Unsystematic Risk


Business Risk
Financial Risk

7. Financial Risk
Assigning Risk Allowances (Premiums)
R= i + p + b + f + m + o
Where:
i = real interest rate (riskless rate)
P = purchasing power risk allowance
B = business risk allowance
F = financial risk allowance
M = market risk allowance
O = allowance for other risks

8. Return & Probability
Return
Likelihood
7
1 chance in 20
8
2 chances in 20
9
4 chances in 20
10
6 chances in 20
11
4 chances in 20
12
2 chances in 20
13
1 chance in 20

9. Starting Predictions “Scientifically”
Return (1)
Probability (2)
(1) X (2)
7
.05
.35
8
.10
9
.20
10
.30
11
.20
12
.10
13
.05

10. Variance & Standard Deviation
Stock
A
Stock
(1)
(2)
(3)
(4)
Return –
Expected
Return
Difference
Squared
Probability
(2) X (3)
B
(5)
(6)
(7)
(8)
Return –
Expected
Return
Difference
Squared
Probability
(6) X (7)
7 -10 =
-3
8 -10 =
-2
9-10 = -1
9-10 = -1
.30
10-10 = 0
10-10 = 0
.40
11-10 = 1
11-10 = 1
.30
12-10 = 2
13-10 = 3
1.00
2.10
1.00
.60
Variance
2.10
.60
S.D.
1.45
.77

11. Risk In a Contemporary Mode
Total Risk = Diversifiable risk + Non diversifiable
Risk
Diversifiable Risk = You can control
Non Diversifiable Risk = You cannot control

12. Thank you