Question

When buying stock, you can expect to earn money through future current income (from ) and future capital appreciation (from ). Together, your total earnings from a given investment can be expressed in terms of the approximate yield. This value makes it easier for you to compare investment options. Understanding the Approximate Yield Equation The formula for the approximate yield of an investment can look intimidating, but it's really just a function of three things: (1) average current income, (2) average capital gains, and (3) the average value of the investment. Based on the information in the table, compute each of these values for the two stocks over a 3-year period and enter the values into the bottom half of the table. Expected average annual dividends (2012-2014) Current stock price Expected future stock price (2014) Stock 1 $1.20 $50 $71 Stock 2 $2.90 $117 $141 Average current income (CI) Average capital gains (CG) Average value of the investment (VI) Next, derive the correct formula for approximate yield by correctly arranging these three variables in the equation that follows. Approximate Vield - F Approximate Yield = and the approximate yield for Using this formula, you can see that the approximate yield for Stock 1 is Stock 2 is True or False: For these investments to be equally attractive, Stock 1 must carry lower risk than Stock 2. False True

Answer 1

1.
Dividends

2.
Price increase

3.
Stock 1
CI=1.20
CG=(71-50)/2=10.50
VI=50+1.20+10.50=61.70

Stock 2
CI=2.90
CG=(141-117)/2=12.00
VI=117+12.00+2.90=131.90

4.
Approximate Yield=VI/Current Stock Price-1

5.
=61.70/50-1
=23.40%

6.
=131.90/117-1
=12.7350%

7.
False