You purchase 100 shares of stock for $60 a share. The stock pays a $3 per share

Question

You purchase 100 shares of stock for $60 a share. The stock pays a $3 per share dividend at year-end.

a. What is the rate of return on your investment if the end-of-year stock price is (i) $57; (ii) $60; (iii) $66? (Leave no cells blank - be certain to enter "0" wherever required. Enter your answers as a whole percent.)

Stock price       Rate of return

$57                     _____%
$60                     _____%
$66                     _____%

b. What is your real (inflation-adjusted) rate of return if the inflation rate is 4%? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Negative amounts should be indicated by a minus sign.)

Stock price       Rate of return

$57                     _____%
$60                     _____%
$66                     _____%

Explanation / Answer

a. The rate of return is the dividend yield + Capital gains yield

1. At 57, the dividend yield = 3/60 = 5%. Capital gains yield = -3/60 = -5%. Hence rate of return = 5%-5% = 0%

2. At 60, the dividend yield = 3/60 = 5%. Capital gains yield = 0/60 =0%. Hence rate of return = 5% + 0% = 5%

3. At 66, the dividend yield = 3/60 = 5%, Capital gains yield = 6/60 =10%.Hence rate of return = 5% + 10% = 15%

b. When inflation rate is 4%, the real rate is given by (NR-IR)/(1+IR)*100

1. At $57, nominal rate is 0%. So real rate =(0-0.04)/1.04*100 = -3.85% (negative)

2. At $60, nominal rate is 5%. So real rate =(0.05-0.04)/1.04*100 = 0.96%

3. At $66, nominal rate is 15%. So real rate =(0.15-0.04)/1.04*100 = 10.58%

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