Question

What makes for a good investment? Use the approximate yield formula or a financial calculator to rank the following investments according to their expected returns. Round the answers to two decimal places. Do not round intermediate calculations.

1. Buy a stock for $45 a share, hold it for 3 years, then sell it for $80 a share (the stock pays annual dividends of $3 a share).
   _________ %
   
2. Buy a security for $20, hold it for 3 years, then sell it for $60 (current income on this security is zero). Do not round intermediate calculations.
   _________%
   
3. Buy a 1-year, 12 percent note for $940 (assume that the note has a $1,000 par value and that it will be held to maturity). Do not round intermediate calculations.
   _________%

If you could please show the work, if not its fine. Thanks.

Answer 1

a. The return is computed as shown below:

= ( $ 80 - $ 45 ) / 3 + $ 3

= $ 14.67 Approximately

The average of buying and selling price is computed as follows:

= ( $ 80 + $ 45 ) / 2

= $ 62.5

So the approximate yield will be:

= $ 14.67 / $ 62.5

= 23.47% Approximately

b. The return is computed as shown below:

= ( $ 60 - $ 20 ) / 3

= $ 13.33 Approximately

The average of buying and selling price is computed as follows:

= ( $ 60 + $ 20 ) / 2

= $ 40

So the approximate yield will be:

= $ 13.33 / $ 40

= 33.33 % Approximately

c. The return is computed as follows:

= 12% x $ 1,000 + $ 1,000 - $ 940

= $ 180

Average of $ 1,000 and $ 940 will be:

= ( $ 1,000 + $ 940 ) / 2

= $ 970

So the approximate yield will be:

= $ 180 / $ 970

= 18.56% Approximately

So the rank will be as follows:

Option b, Option a and then option c.

Feel free to ask in case of any query relating to this question