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Financial Terms related to Return This document is part of the valuable contents available at www.ftpall.com, a free online glossary with more than five thousand financial and business terms. This document can be copied and distributed freely Find thousands of financial terms at www.ftpall.com respecting its original format. It is forbidden its transcription, translation or change on its format without authorization of its author or editor. RETURN Abnormal returns • Part of the return that is not due to systematic influences (market wide influences). In other words, abnormal returns are above those predicted by the market movement alone. Related: excess returns. After tax real rate of return • Money after-tax rate of return minus the inflation rate. • Money after-tax rate of return minus the inflation rate. Hence, this refers to the purchasing power increase. Annualized holding period return • The annual rate of return that when compounded t times, would have given the same t-period holding return as actually occurred from period 1 to period t. Arithmetic average mean rate of return www.ftpall.com 2|Page • Arithmetic mean return. Arithmetic mean return • An average of the sub period returns, calculated by summing the sub period returns and dividing by he number of sub periods. Average accounting return • The average project earnings after taxes and depreciation divided by the average book value of the investment during its life. Find thousands of financial terms at www.ftpall.com Average rate of return • Abbreviated ARR. The ratio of the average cash inflow to the amount invested. Cumulative abnormal return • Abbreviated CAR. Sum of the differences between the expected return on a stock and the actual return that comes from the release of news to the market. Dollar return • The return realized on a portfolio for any evaluation period, including (1) the change in market value of the portfolio and (2) any distributions made from the portfolio during that period. Dollar weighted rate of return • Also called the internal rate of return, the interest rate that will make the present value of the cash flows from all the subperiods in the evaluation period plus the terminal market value of the portfolio equal to the initial market value of the portfolio. Ex post return • Related: Holding period return Exante return • The expected return of a portfolio based on the expected returns of its component www.ftpall.com 3|Page assets and their weights. Excess return on the market portfolio • The difference between the return on the market portfolio and the risk less rate. Excess returns • Also called abnormal returns, returns in excess of those required by some asset pricing model. • Returns in excess of the risk-free rate or in excess of a market measure such as Find thousands of financial terms at www.ftpall.com the S&P 500 index. Expected excess return • Is equal to the nonmarket or alpha return plus the beta-adjusted market or systematic return. Since beta relates an asset's return to the market, then the alpha distinguishes it from the market. Algebraically, this is presented by the expression for a straight line or excess return equals a (alpha) + b (beta)X (market return). Expected future return • The return that is expected to be earned on an asset in the future. Also called the expected return. Expected return • The return expected on a risky asset based on a probability distribution for the possible rates of return. Expected return equals some risk free rate (generally the prevailing U.S. Treasury note or bond rate) plus a risk premium (the difference between the historic market return, based upon a well diversified index such as the S&P500 and historic U.S. Treasury bond) multiplied by the assets beta. • Expected Return shows what the lender expects to earn after adjusting for the probability of missed payments, late payments, outright defaults, etc. • The average of a probability distribution of possible returns. www.ftpall.com 4|Page • The return that is expected to be earned each period on a given asset over an infinite time horizon. Expected return beta relationship • Implication of the CAPM that security risk premiums will be proportional to beta. Expected return on investment • The return one can expect to earn on an investment. See: capital asset pricing model. Find thousands of financial terms at www.ftpall.com Expected value of a return • The most likely return on a given asset. Geometric mean return • Also called the time weighted rate of return, a measure of the compounded rate of growth of the initial portfolio market value during the evaluation period, assuming that all cash distributions are reinvested in the portfolio. It is computed by taking the geometric average of the portfolio sub period returns. Holding period return • The rate of return over a given period. Holding period return/yield • Income plus price appreciation during a specified time period divided by the cost of the investment. Horizon return • Total return over a given horizon. Implied return • The sum of implied internal growth plus the projected average Dividend Yield. Incremental internal rate of return www.ftpall.com 5|Page • IRR on the incremental investment from choosing a large project instead of a smaller project. Internal rate of return • Abbreviated IRR. The discount rate that equates the present value of cash inflows with the initial cost of a capital budgeting project; the discount rate that makes the NPV of the project equal to $0. • Dollar-weighted rate of return. Discount rate at which net present value (NPV) investment is zero. The rate at which a bond's future cash flows, discounted back to Find thousands of financial terms at www.ftpall.com today, equals its price. Internal rate of return approach • An approach to capital rationing that involves the graphic plotting of project IRRs in descending order against the total dollar investment to determine the group of acceptable projects. Internal rate of return irr • This shows the profitability of a project or a bond. It is computed by setting IRR equal to the discount rate that makes the net present value of the cash flows equal to zero. Leveraged required return • The required return on an investment when the investment is financed partially by debt. Market return • The expected return on the market portfolio of all traded securities. Since it is an expected return, it is always greater than the risk-free rate of return because market participants are assumed to be risk-averse wealth maximizers. • The return on the market portfolio. www.ftpall.com 6|Page Market risk return function • A graph of the discount rates associated with each level of project risk. Money rate of return • Annual money return as a percentage of asset value. • Annual return as a percentage of asset value. Multiple rates of return • More than one rate of return from the same project that make the net present value Find thousands of financial terms at www.ftpall.com of the project equal to zero. This situation arises when the IRR method is used for a project in which negative cash flows follow positive cash flows. For each sign change in the cash flows, there is a rate of return. Portfolio internal rate of return • The rate of return computed by first determining the cash flows for all the bonds in the portfolio and then finding the interest rate that will make the present value of the cash flows equal to the market value of the portfolio. Potential total return • Suggests the potential compounded return on your investment over 5 years, based on expected growth of EPS. It supposes that you bought the stock at the current price, earned the average dividend yield, and sold at the forecast high price to achieve the potential annual price appreciation. Promised return • Promised Return is what the borrower agrees to pay at the time loan is taken. For instance, if the loan amount is $1,000 and the agreed return is 10%, the borrower is promising to pay $100 in interest payments for the first year. Rate of return • The yield obtainable on a security based on its purchase price or its current market www.ftpall.com 7|Page price. This may be the amortized yield to maturity on a bond the current income return. Rate of return ratios • Ratios that are designed to measure the profitability of the firm in relation to various measures of the funds invested in the firm. Real rate of return • The annual percentage return realized on an investment, adjusted for changes in Find thousands of financial terms at www.ftpall.com the price level due to inflation or deflation. Real return bonds • Abbreviated RRB. Bonds that adjust the semi-annual coupon payments and the par value for inflation. Realized return • The return that is actually earned over a given time period. Required return • The minimum return required by investors given the risk of an investment and the risk-free rate and the market-determined premium for risk. The required return is that rate of return predicted by the CAPM (capital asset pricing model) formula. • The minimum expected return you would require to be willing to purchase the asset, that is, to make the investment. Return • The total gain or loss experienced on an investment over a given period of time; calculated by dividing the asset's change in value plus any cash distributions during the period by its beginning-of-period investment value. • The percentage gain or loss for a security in a particular period, consisting of income plus capital gains relative to investment. The Real Rate of Return is the www.ftpall.com 8|Page annual return realized on that investment, adjusted for changes in the price due to inflation. • The change in the value of a portfolio over an evaluation period, including any distributions made from the portfolio during that period. Return on assets • Abbreviated ROA. Calculated by dividing a company's annual earnings by its total assets, displayed as a percentage. Useful to indicate how profitable a company is relative to its total assets. Find thousands of financial terms at www.ftpall.com • Abbreviated ROA. Indicator of profitability. Determined by dividing net income for the past 12 months by total average assets. Result is shown as a percentage. ROA can be decomposed into return on sales (net income/sales) multiplied by asset utilization (sales/assets). Return on equity • Abbreviated ROE. Measures the return earned on the owners' (both preferred and common shareholders') investment in the firm. • Abbreviated ROE. Also known as Earned on Equity. ROE tells how effectively company management is using the shareholders' money to make a profit. This is useful for comparisons among companies. A simple formula is Net Income divided by Shareholders' Equity. Generally, the higher the ROE, the more efficient the management and the better the return to shareholders. It is expected that there will be some variation in the ROE numbers over time. For example, issuing more shares increases shareholders' equity. This causes the return on equity to decline until management can invest the new funds and generate new earnings. Another decline in the ROE trend can occur when a company relies heavily on debt. If interest expenses rise significantly, net income will likely be reduced. Therefore www.ftpall.com 9|Page ROE will be less. Return on equity is a balancing act between careful use of debt and good use of assets. • Abbreviated ROE. Indicator of profitability. Determined by dividing net income for the past 12 months by common stockholder equity (adjusted for stock splits). Result is shown as a percentage. Investors use ROE as a measure of how a company is using its money. ROE may be decomposed into return on assets (ROA) multiplied by financial leverage (total assets/total equity). Return on investment Find thousands of financial terms at www.ftpall.com • Abbreviated ROI. The profit or loss resulting from a security transaction, often expressed as an annual percentage rate. • Abbreviated ROI. Generally, book income as a proportion of net book value. Return on total assets • Abbreviated ROA. Measures the overall effectiveness of management in generating profits with its available assets; also called return on investment (ROI). • The ratio of earnings available to common stockholders to total assets. Return to maturity expectations • A variant of pure expectations theory which suggests that the return that an investor will realize by rolling over short-term bonds to some investment horizon will be the same as holding a zero-coupon bond with a maturity that is the same as that investment horizon. Risk adjusted return • Return earned on an asset normalized for the amount of risk associated with that asset. Risk return tradeoff • The expectation that for accepting greater risk, investors must be compensated www.ftpall.com 10 | P a g e with greater returns. Risk/return trade off • The balance an investor must decide on between the desire for low risk and high returns; low levels of uncertainty (low risk) are associated with low potential returns, and high levels of uncertainty (high risk) are associated with high potential returns. Safety net return • The minimum available return that will trigger an immunization strategy in a Find thousands of financial terms at www.ftpall.com contingent immunization strategy. Subperiod return • The return of a portfolio over a shorter period of time than the evaluation period. T period holding period return • The percentage return over the T-year period an investment lasts. Time weighted rate of return • Related: Geometric mean return. Total dollar return • The dollar return on a non dollar investment, which includes the sum of any dividend/interest income, capital gains or losses, and currency gains or losses on the investment. See also: total return Total rate of return • A measure of a portfolio's performance over time. It is the internal rate of return that equates the beginning value of the portfolio with the ending value, and includes interest earnings and realized and unrealized gains and losses on the portfolio. • The compounded annual return on an investment, including price appreciation and dividends or interest. www.ftpall.com 11 | P a g e • In performance measurement, the actual rate of return realized over some evaluation period. In fixed income analysis, the potential return that considers all three sources of return (coupon interest, interest on interest, and any capital gain/loss) over some investment horizon. • Refers to the change in asset value plus income. For a stock it would refer to the change in the adjusted stock price plus and dividends and other distributions, if any. For a bond it would reflect the change in bond price plus any interest received or accrued. It more completely measures the overall perform of an investment. Find thousands of financial terms at www.ftpall.com Unleveraged required return • The required return on an investment when the investment is financed entirely by equity (i.e. no debt).