Rates of return refer to the percentage increase or decrease in an investment's
value over a specific period, usually expressed annually or as a cumulative return
over a specified period. It is a measure of the profitability of an investment and is a
crucial metric used by investors to evaluate the performance of their investments.
Holding-Period Return (HPR) is a financial metric used to measure the return an investor
earns on an investment over a specific period of time, typically expressed as a
percentage. The HPR is calculated by taking the difference between the ending price
and beginning price of an investment, adding any dividends or distributions received
during the holding period, and dividing the sum by the beginning price. The formula for
calculating HPR is:
HPR = (Ending Price + Dividends - Beginning Price) / Beginning Price
For example, suppose an investor purchased a stock for $50 per share and sold it a year
later for $60 per share, while also receiving $2 in dividends during the holding period.
The HPR would be calculated as follows:
HPR = (60 + 2 - 50) / 50 = 0.24 or 24%
This means that the investor earned a 24% return on their investment over the one-
year holding period. HPR is a useful metric for comparing the performance of different
investments or portfolios over a specific period of time.
Measuring over multiple periods refers to the practice of collecting and analyzing
data over a defined period of time in order to track changes and trends over that
period.
Arithmetic average, also known as arithmetic mean or simply mean, is a
measure of central tendency that is calculated by adding up a set of values
and dividing the sum by the total number of values.
For example, if we have the following set of numbers: 4, 6, 8, 10, the
arithmetic average is calculated as follows:
(4 + 6 + 8 + 10) / 4 = 28 / 4 = 7
Therefore, the arithmetic average of this set of numbers is 7.
The geometric average, also known as the geometric mean, is a type of average
that is used to find the central tendency of a set of numbers. It is calculated by
taking the nth root of the product of n numbers, where n is the number of items in
the set.
Dollar-weighted average return (also known as the internal rate of return or the
time-weighted rate of return) is a financial metric that measures the average annual
return earned by an investment over a specific period of time.
Annual Percentage Rate (APR) is a financial term used to express the cost of
borrowing money on an annual basis. It is the annual interest rate that a
lender charges on a loan, including any additional fees or charges that may
be associated with the loan.
APR is typically used for mortgage loans, car loans, and credit cards. It is
important for borrowers to understand the APR because it gives them a more
accurate picture of the total cost of borrowing.
For example, if a borrower takes out a $10,000 loan with a 5% APR and a
repayment period of 1 year, the total amount paid back would be $10,500
($10,000 plus 5% interest). However, if the same loan also comes with
additional fees such as processing fees or origination fees, those fees would
also be included in the APR calculation, resulting in a higher overall cost of
borrowing.
The Effective Annual Rate (EAR) is a financial term that represents the true
annual interest rate that is actually earned or paid on an investment, loan or
other financial product, taking into account compounding of interest over a
period of time.
In simple terms, EAR is the total amount of interest that would be earned or
paid in a year, expressed as a percentage of the initial investment or loan
amount.
To calculate the EAR, you need to take into account the compounding
frequency and the nominal interest rate. The formula for calculating EAR is:
EAR = (1 + (nominal interest rate/compounding frequency))^compounding
frequency - 1
For example, if you have a loan with a nominal interest rate of 6% per year,
compounded monthly, the EAR would be:
EAR = (1 + (0.06/12))^12 - 1 = 6.17%
This means that the effective annual interest rate on the loan is 6.17%,
taking into account the monthly compounding of interest.
