LOS 1.e

Question 1

What is the Gross Return, Net Return, Pretax nominal Return, After Tax-Nominal Return, and Real Return

Answer 1

• Gross return = total return before deducting fees for management and admin of investment account
• Net Return = return after feees for management and admin of investment account have been deducted
• Pretax nominal return = return before paying taxes (Dividend income, interest income, short term capital gains, long term capital gains)
• Real return = Nominal return adjusted for inflation

Question 2

What is real return and how do you calculate it?

Answer 2

• Definition: measuring increase in investors purcahsing power, how much their investment has increased, along with the change in their purchasing power
• Calculation: (1+nominal risk-free rate)(1+risk premium) / (1+inflation premium)

Question 3

What is leveraged return and how do you calculate it?

Answer 3

• Definition: refers to the return to an investor that is a multiple of the return of the underlying assets - the gain or less on the investment as a percentage of the investors cash investment.
• Leverage is like using borrowed money to amplify your investment returns. Imagine you have £100 to invest, but you borrow another £100. Now you have £200 working for you. If your investments go up 10%, you make £20 instead of just £10. That’s leverage! However, leverage is a double-edged sword. If your investments go down 10%, you lose £20 instead of £10. Plus, you have to pay interest on the money you borrowed
• Calculation: leveraged return = (r (Vo + Vb) - rbVb) / Vo
• Vo = The initial investment, Vb = extra money borrowed, r = the percentage gain/loss, rb = the cost of borrowing