Question

What makes for a good investment? Use the approximate yield formula or a financial calculator to rank the following investments according to their expected returns. Round the answers to two decimal places. Do not round intermediate calculations.

a.) Buy a stock for $45 a share, hold it for 2 years, then sell it for $80 a share (the stock pays annual dividends of $3 a share).
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b.)Buy a security for $25, hold it for 2 years, then sell it for $65 (current income on this security is zero). Do not round intermediate calculations.

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c.)Buy a 1-year, 10 percent note for $960 (assume that the note has a $1,000 par value and that it will be held to maturity). Do not round intermediate calculations.

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Answer 1

Good Investment - Generally, if return is very high or higher than that of comparable assets, we can say this is goods investment. But with high return involves high risk too and low return involves low risk. So, for good investment, we should look after risk -return ratio.

A) Return on Stock = Dividend yield + capital Gain

= 3/45 + (80-45)/45 = 84.44% ( Which received in 2 years)

Annual return year = (1+84.44%)^(1/2) -1 = 35.81 %

B) Return / Year

35 (1+r)² = 65

r = (65/35)^(1/2) - 1 = 36.28 %

C) Lets assume return - i

Coupon = 10% of 1000 = 100

960 = (10% + 1000 + 1000)/(1+i)

I = 1100/960 -1 = 14.58%

Expected Return ( From High to low)

B-------------> A------------------C