Question

1. Calculate a one-year holding period return for the following two investments alternatives.

Which investment would you prefer, assuming they are of equal risk? Explain.

            Investment  

X                                 Y

Cash received

1^st quarter                                                                                             $1.00                           $0.00

2^nd quarter                                                                                            $1.20                           $0.00

3^rd quarter                                                                                            $0.00                           $0.00

4^th quarter                                                                                            $2.30                           $2.00

Investment value

Beginning of Year                                                                                $30.00                         $50.00

End of year                                                                                          $29.00                         $56.00

Answer 1

Holding period return (HPR) = [income (dividends) + (ending value - beginning value ) ] / beginning value

Investment X HPR = [ (1+1.2+2.3) + ( -29 - 30 ) / 30] = -1.81667 or -181.667 %

Investment Y HPR = [ ( 2 + (56 - 50) ] / 50 = 0.16 or 16%

Considering both investments have equal risks, Investment Y should be the preferred choice since it has a higher holding period return. Despite Investment X giving out higher dividends, it still has lower value at the end of the year, making the investment yield negative returns. Investment Y alongwith with the dividends, yields a higher value at the end of the year and thus a higher return.