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P1 P 0+ D1
P0
HPR =
Cash dividend
Rupee return (R0) =
P1P0 + D1
ii.
P1 P 0+ D1+ D 2
P0
P1 P 0+ D1(1+ R)+ D2
P0
where
GM ( HPR g ) =
1
n
(1+ HP Rt ) 1
t=1
-1
= the product
HP R 1+ HP R2 + HP Rn
N
HPR
N
Arithmetic mean HPR and Geometric mean HPR are different because
1. Arithmetic mean doesnt consider time value of money but geometric mean
consider the time value of money or re-investment concept
2. AM and GM HPR will only be equal when the HPR are constant over the
investment horizon.
3. AM is suitable for one period or single period but GM is suitable for multiperiod rate of return.
4. AM HPR will be always greater than GM in case of variation of return.
Expected rate of return, Mean rate of return and average rate of return (HPR j)
If probability distribution is given, E(HPR) or
j
HPR
Ps -
HPR j
HP R j
N
Meaning of risk
Business Risk: uncertain about the rate of return caused by nature of business.
[ causes of business risk are uncertain about the firms sale and operating
expenses]
Financial risk: Risk related to firms capital structure
Liquidity risk: related with the uncertainity created by the inability to sell the
investment quickly for cash
Interest rate risk: changes in the interest rate in market
Managerial risk: risk created due to different management policies decision
Purchasing power risk: Risk caused by inflation
Measurement of risk:
-
Variance
If probability distribution of return is given,
Step 1: Calculate the expected mean return,
j
HPR
j)
( HPR
j
HPR
Ps -
HPR j
HPR j
Deviation =
j
HPR
Step 3: Square of each deviation, multiply the result by the probability of occurrence
for its related outcome and then sum their product to obtain the variance
Variance ( j
)=
P s ( HP R j HP R j)2
HP R j
HP R j=
N
Step 2: Subtract the expected rate of return
HP R j
HP R j
HP R j
2
Step 3: Variance ( j ) =
Standard deviation =
HP R j
(HP R j HP R j )2
N
Variance
Co-efficient of variations(CV)
CVj =
-
j
standard deviation
=
Mean return
HP R j