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ROI (Return on Investment)
Return is basically the over and above on your actual value. In the same way Return on Investment is the excess amount earned through capital gain, in the form of dividend and in the form of interest on your actual investment value over the period of time.
Example: You invest $100 in the year 2021 and buy 2 shares of Cisco Systems, Inc. and you received dividend of $1 per share and suppose price of 1 shares of Cisco Systems, Inc. now is $60 so your total return = $20 + $2 ($10*2 + $1*2)
Return on Investment = ($22/$100)*100
= 22%
Types of Return involved in Portfolio Evaluation:
1. Historical Return (Ex-Post-Return)
These return is calculated on the basis of past price fluctuations. It is the return by holding a particular securities investment over a period of time.
Example: Year Price Dividend / Interest
2017 $30 $0.1
2018 $34 $0.4
2019 $37 $0.2
2020 $25 $0.6
2021 $45 $0.1
2022 $46 $0.3
These return is calculated on the basis of past price fluctuations. It is the return by holding a particular securities investment over a period of time.
Example: Year Price Dividend / Interest
2017 $30 $0.1
2018 $34 $0.4
2019 $37 $0.2
2020 $25 $0.6
2021 $45 $0.1
2022 $46 $0.3
Mean Return = ∑Ri/n
2. Expected Return (Ex-ante-Return)
These returns are represented by the probability distribution of the return over specific period of time. These return calculated based on estimated return on the basis of past experience.
Example: Outcome Return Probability
Optimistic 30% 0.2
Pessimistic 10% 0.3
Base 15% 0.5
Expected Return = 30*0.2 + 10*0.3 + 15*0.5
= 16.5%
3. Holding Period Return
This is the total return earned on an investments over its holding period. It is also called Total Return.
To Calculate the Holding Period we use the formula as mentioned below:
Holding Period Return = Dividend or Interest + (Selling Price – Buying Price) *100
Buying Price
4. Average Return
It is an annual average return over the holding period of the investment securities. It can be computed in two ways:
a) Simple Arithmetic Average Return = (R1 +R2 +R3 +Rn)/n
Where, N = Holding Period.
b) Geometric Mean based Average Return = {[(1+R1) * (1+R2) * (1+R3) * (1+Rn)]^1/n}-1
Where, N = Holding Period
5. Effective Annualized Return
This type of return is calculated when you hold that investment avenue for more than one year. It is an equivalent per annum return generated by an investment. It is calculated as:
Effective Annualized Return = (1+Rn)1/n
Where, Rn = Holding Period Return
n = Holding Period of the investment
Example: A 12 year zero coupon bond of face value $10 is available now at $3.5.
Total Return = (10-3.5)/3.5
= 1.857 or 185.71%
6. Absolute Return
Absolute returns are the sum of the total dividend, interest received during the holding period of the investments add the capital gain due to the rise in price of the securities in any. This return is are compared without considering the risk associated with the investments.
7. Risk Adjusted Return (Risk relative Return)
These return is calculated as excess return above risk free rate of return earned per unit of the risk.
Risk Adjusted Return = Absolute Return – Risk free Return
Risk in terms of β or ∂
The investment securities which have higher degree of risk relative return is preferable.
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