Stock Purchase Decisions Essays Example
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Holding Period Return for each stock
Holding Period Return is the total return earned from holding a given stock or portfolio of stocks over a particular period of time.
Holding Period Return = Dividend income+(End of Period Share Price - Initial Share Price)Initial Share Price
HPR for Stock X
HPR for Stock Y
Expected return = Average HPR
Expected return for Stock X = 15+ 2.27+20.95+ -1.25+13.18+20+2.69+4+21.25+19.2610
Expected return for Stock Y = 7.5-1.82+ 3.33-5 + 4.09 + 4.35-3.46 + 0.8 + 9.58 + 1.4810
Standard deviation =P(EiR-HPR)2
P is the probability of occurrence. In this case, each of the ten years is treated equally and assigned equal probabilities. Alternatively, the sum of the squared variations from the expected return may be divided by the number of years to obtain the variance.
Standard deviation for Stock X = 0.007130
Standard deviation for Stock Y = 0.011266
Return and risks associated with stocks X and Y
Given the movements in share prices and the dividend income received over the ten years, the holding period return gives us the total return Molly expects to earn if she invests in the two shares. As shown by the above calculations, the average holding period return for Stock X is 11.74%. This implies that Molly will gain a total of the annual return of 11.74% over and above the initial cost of the stock if she buys the stock and holds it for a period of ten years (Brigham & Houston, 2011). For instance, if Molly purchases Stock X if its market price is $20, she expects to earn a return $2.348 annually. The total dividends declared by the issuing company, as well as appreciation in the value of Stock X in the stock market, will be $2.348.
Stock Y has an average holding period return of 2.09%. It shows that Molly will earn a 2.09% return annually on the stock if she purchases it and holds it for ten years. For instance, if Molly buys Stock Y when its market price is $20, it will earn a total of $0.418 in terms of dividends and stock appreciation. The expected return from stock X is, therefore, higher than that of Stock Y.
The standard deviation for Stock X is 0.0844 indicating the expected deviation of the actual return from the expected returns is 0.0844. Thus, the expected volatility of stock X returns is 0.0844. On the other hand, Stock Y has a standard deviation of 0.1061. This indicates that the expected variation of returns from the expected return is 0.1061. The standard deviation of stock X is less than that of stock X indicating that the returns of stock Y are more volatile than those of stock X (Brigham & Houston, 2011). It further implies that Stock Y has a higher risk than stock X.
I would advise Molly to purchase Stock X since it has a higher return than Stock Y. This shows that she will gain more if she buys stock X than if she purchases stock Y. In terms of risk, stock X is less risky as compared to Y. The high volatility of stock Y indicates that even the expected return may not be achieved because the expected variation of the actual returns from the expected return is higher than for Stock X. Stock X will, therefore, maximize her returns and minimize her risk.
Brigham, E., & Houston, J. (2011). Fundamentals of financial management (7th ed.). Mason, OH: South-Western Cenage Learning.
Graham, J., & Smart, S. (2011). Introduction to Corporate Finance: What Companies Do (3rd ed.). New York: Cengage Learning.
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