Risk and Return Measures - Measures of Investment Return (Contd.)

  1. Real Return/Nominal Return - real return is nothing more than the nominal (gross) return adjusted for inflation. The formula reads as follows:

    Real Return = (1+Nominal Return/1+Inflation Rate) -1 x 100
In calculating the real return, one should take care to use a realistic inflation rate with which to make the adjustment.
  1. Total Return - measures the change in value, adding or subtracting any cash flows divided by the initial investment.
  2. Risk-Adjusted Return - this return is adjusted for the risk taken which enables the investor to determine whether the return was worth the risk assumed to obtain it. Please refer to the Performance Measures discussion in Chapter 7 "Portfolio Development and Analysis" for a review of the calculation methodology and rationale behind the Sharpe, Treynor, Jensen and Information ratios.
  3. Holding Period Return (single period return) - used to evaluate how quickly an investment increases or decreases in value, it is the most basic calculation, at which one arrives by dividing the change in wealth by the initial investment. The formula reads as follows:

Real Return = (1+Nominal Return/1+Inflation Rate) -1 x 100

  1. Internal Rate of Return (IRR) - the earnings rate that equates a series of cash flows to the present value of a given investment. IRR assumes that the investment's cash flows will be reinvested at the investment's internal rate of return.

HPR = Ending Value of Investment-Beginning Value of Investment +/- Cash flows/Beginning Value of Investment

  1. Yield-to-Maturity (YTM) - the internal rate of return calculation used for fixed income. One may compute it using a financial calculator that performs time value of money calculations. The inputs are as follows: PV=present value of the security. CF=the size of each cash flows for the period in question. N= the number of cash flows to be evaluated. I=the IRR for which the candidate solves using all of the foregoing inputs.
  2. Yield-to-Call (YTC) - the internal rate of return calculation used for callable bonds. The assumption is that the cash flows are reinvested at the IRR until the bond is called. One would use the same methodology for yield to maturity to calculate the yield to call.
  3. Current Yield (CY) - the dollar value of the annual coupon divided by the bond's current market value. The follow example will illustrate this:
A corporate bond is paying 8% and is selling at $1,080. Its current yield is computed as follows: $80/$1080=7.4%
Remember that the annual coupon expressed in dollar terms is the bond's percentage multiplied by its par value (.08 x $1,000=$80)

Taxable Equivalent Yield (TEY)
Related Articles
  1. Investing

    Time to Bring Active Back into a Portfolio?

    While stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
  2. Retirement

    Two Heads Are Better Than One With Your Finances

    We discuss the advantages of seeking professional help when it comes to managing our retirement account.
  3. Personal Finance

    How the Social Security Reboot May Affect You

    While there’s still potential for some “tweaking” around your Social Security retirement benefits, I’d like to share some insight on what we know now.
  4. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  5. Entrepreneurship

    Creating a Risk Management Plan for Your Small Business

    Learn how a complete risk management plan can minimize or eliminate your financial exposure through insurance and prevention solutions.
  6. Investing Basics

    5 Tips For Diversifying Your Portfolio

    A diversified portfolio will protect you in a tough market. Get some solid tips here!
  7. Entrepreneurship

    Identifying And Managing Business Risks

    There are a lot of risks associated with running a business, but there are an equal number of ways to prepare for and manage them.
  8. Active Trading

    10 Steps To Building A Winning Trading Plan

    It's impossible to avoid disaster without trading rules - make sure you know how to devise them for yourself.
  9. Trading Strategies

    How to Trade In a Flat Market

    Reduce position size by 50% to 75% in a flat market.
  10. Credit & Loans

    Unsecured Personal Loans: 8 Sneaky Traps

    If you are seeking a personal loan, be aware of these pitfalls before you proceed.
  1. Equity Risk Premium

    The excess return that investing in the stock market provides ...
  2. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  3. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  4. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  5. Gross Exposure

    The absolute level of a fund's investments.
  6. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  1. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  2. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  3. Why are mutual funds subject to market risk?

    Like all securities, mutual funds are subject to market, or systematic, risk. This is because there is no way to predict ... Read Full Answer >>
  4. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  5. Can your car insurance company check your driving record?

    While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
  6. Do financial advisors work only in banks?

    While the majority of financial advisors work for financial institutions such as banks, a large proportion of them are self-employed ... Read Full Answer >>
Hot Definitions
  1. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  2. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
Trading Center