Rate of return – Definition

Annual percentage rate

What is the rate of return?

The rate of return (or ROR for the rate of return ) is the loss or profit of an investment over a certain period, expressed as a percentage. It measures the return relative to the initial cost of the investment. A positive ROR means the position generated a profit, while a negative ROR means a loss. You will get a rate of return for any investment you make.

To calculate the rate of return on investment, subtract the initial value of the investment from its final value (don’t forget to include dividends and interest). You must then divide this amount by the initial value of the investment, then multiply this figure by 100. This will give the ROR expressed as a percentage.

Rate of return: trading and investing

A rate of return can provide investors with key information about future transactions or investments. The rate of return can be used by traders to gauge the outcome of their trades. However, it is more often used as a long-term calculation by investors, helping to determine whether the cost of an investment is worth the potential profit or loss.

Rate of return: stocks vs bonds

Calculations of the rate of return on stocks and the rate of return on bonds are different because stocks pay dividends, while bonds bear interest.

Example of calculation of the rate of return of equities

Suppose you own two shares of company ABC, bought for 40 CHF each. This means that your initial investment is 80 CHF.

Over a year, Company ABC pays dividends of CHF 2 per share, making a total of CHF 4, and the stock price reaches CHF 50. This means that your total investment would be worth CHF 104 (the value of the shares plus the dividend payments). You then subtract the original value of your investment (80 CHF ) from the new value (104 CHF ) and divide this amount by 80 CHF. Then, to get your percentage rate of return, multiply that figure by 100. This gives an annual rate of return of 30%.

Example of Bond Yield Calculation

On the other hand, if you hold a bond of CHF 100,000 at a 5% interest rate, which matures after four years, you will receive an income of CHF 5,000 each year (value of the bond multiplied by the interest). If you sell the bond at CHF 120,000 after one year, the appreciation of the bond will be CHF 20,000 (by subtracting the original value of the bond from the new value).

The rate of return is calculated by taking the interest plus the appreciation, divided by the initial price of the bond. The rate of return after one year is therefore 25% (CHF 5,000 plus CHF 20,000, divided by CHF 100,000, multiplied by 100).

Trading and investing

A rate of return can provide investors with key information about future transactions or investments. The rate of return can be used by traders to gauge the outcome of their trades. However, it is more often used as a long-term calculation by investors, helping to determine whether the cost of an investment is worth the potential profit or loss.

By Master James

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