CFA Level 1 Stock Market Series Expected Annual Rate of Return | Test Prep

Expected Annual Rate of Return for Stock Market Series

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Question

Assume the following information about a stock market series:

Observed beginning series value: 1677

Anticipated ending series value: 1890

Expected dividends during the period: $16.36

Required rate of return: 19.50% per year

What is the expected annual rate of return for this index? (Assume a one-year holding period.)

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Explanations

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A. B. C. D. E.

D

The anticipated rate of return for this stock market series is found as 13.68%. Thus, none of these answers is correct.

To calculate the expected rate of return for a stock market series, the following information must be known:

The beginning value for the series

The anticipated ending value for the series, and

The amount of any dividends and/or distributions during the period

Once this information has been determined, the expected return on a stock market index can be found by employing the following equation:

E(R) = [(EV - BV + Div) / BV]

Where: E(R) = the expected return on the stock market series, EV = the anticipated ending value for the series, BV = the observed beginning value for the series, and Div = the amount of any dividends paid during the period.

In this example, all of the necessary information has been provided and the calculation of the expected return on this stock market series is found as follows:

E(R) = [$1890 - $1677 + $16.36] / 1677 = 13.68%

This is significantly less than the required rate of return. Assuming that both the ending value and dividend figure is accurate, investment in this stock market series is likely not warranted.