Anticipated Rate of Return for Stock Market Series

Calculating the Anticipated Annual Rate of Return

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Question

Jones Rutherford, a portfolio manager with Churn Brothers Brokerage, has been examining a stock market series and is trying to determine the anticipated rate of return for the series. In his analysis, Jones has amassed the following information:

Anticipated ending series value: 1475

Expected dividends during the period: $35

Observed beginning series value: 1310

Required rate of return: 19% per year

What is the anticipated annual rate of return for this stock market series? (Assume a one-year holding period).

Answers

Explanations

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Explanation

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) = [$1475 - $1310 + $35] / $1310 = 15.27%

This is less than the required rate of return. Assuming that the figures for the ending value and the expected dividends are accurate, then investment in this stock market series is not likely warranted.

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