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Question 5: [Calculation-Based] Risk and Return
Part 1: Calculating rates of return: On 12 December 2007, the ordinary shares of Qantas Airways Ltd (QAN) were trading for $5.75. One year later, the shares sold for $2.24. During that period, Qantas paid dividends totalling $0.35.
a. What rate of return would you have earned on your investment had you purchased the shares on 12 December 2007 and sold them on 12 December 2008?
b Describe, in your own words, the concept of a realised of return.
c. How do cash dividends affect the realised rate of return from investing in ordinary shares?
d. Why is volatility in an investment’s rate of return a reasonable indication of the risk of an investment?
Part 2: Calculating rates of return: The S&P/ASX 200 share price index represents a portfolio which comprises the 200 largest companies listed on the Australian Securities Exchange. On 12 December 2007, the index had a value of 6615.2 and on 12 December 2008 the index had a value of 3510.4.3. If the average dividend paid on the shares in the index is approximately 4% of the value of the index at the beginning of the year, what is the rate of return earned on the S&P/ASX 200 index?
What is your assessment of the relative riskiness of the Qantas Airways investment (analysed in the previous problem) compared to investing in the S&P/ASX 200 index (recall from Chapter 2 that you can purchase managed funds that mimic the returns on the index)?
Question 6: [Theory] Risk and Return
Part 1 Describe the relationship between the expected rate of return for an individual investment and the expected rate of return for a portfolio of several investments.
Part 2 Portfolio diversification is affected by the volatility of the returns of the individual investments in the portfolio as well as the
correlation among the returns. Explain this statement.
The expected return rate may be defined as the rate of return which an investor expects or anticipates earning on the investment made by him (Fidelity International, 2017). Returns earned in previous years are taken as a base to compute this rate. It is neither the actual rate nor guarantees that the earned return will be similar to the expected rate.
A portfolio is a basket of various assets which is preferred for investment purpose. Its expected return rate shows the anticipated returns. It is related to an expected rate of return on share as a shares' expected return rate is taken as a base for computing the expected rate of return on the portfolio (Damodaran, 2014). Any changes in the expected rate of return on a single asset lead to a change in the expected rate of return for a portfolio in the same direction.
Rate of return (Rp) = Weighted average value of expected returns on individual assets
E(Rp) = Wi1 E(Ri)1 + Wi2 E(Ri)2 + Wi3 E(Ri)3 +…………………….. Win E(Ri)n
E(Rp) is the expected rate of return on portfolio
Wi is the weights of individual investment
E(Ri) is the rate of return on individual investment