2.2 Security Return: The Holding Period Return (Raw Calculation)
In order to figure the return on an asset (a percent), it is useful to first outline the various components of the return on the asset – and then to calculate the return. The two principal components of return are income and sales or “exit” price. Income is common to many assets including bonds (interest), stocks (dividends), and real estate (rent), which may provide income payments of interest, dividends, and rent respectively. The exit price may be equal to, greater or less than the asset’s investment cost.
| Income on Financial Assets | ||
|---|---|---|
| Bonds | Stock | Real Estate |
| Interest | Dividends | Rent |
Example:
- Stock/bond cost or investment (C) = $1,000. This is an “outflow.”
- Income (I) from rent, interest, and/or dividends received over the course of the holding period = $100
- Sales (exit) price (P) = $1,100.
- The income and sales price are “inflows.”
Holding Period Return (HPR):
| HPR | = inflows ÷ outflows |
| = [(I + P) ÷ C] – 1 | |
| HPR | = [(100 + 1,100) ÷ 1,000] – 1 |
| = + 20% |
Alternatively, we could have calculated the HPR by focusing only on the profit (Π), in which case, we would have left out the “-1” expression at the end. The result is the same.
| HPR | = [(I + Π) ÷ C] |
| HPR | = [(100 + 100) ÷ 1,000] |
| = + 20% |
Note:
In either application, this is a “raw” calculation in that it does not account for the time value of money. This approach ignores the length of the holding period and the timing of the cash flows. Clearly one would rather earn the raw 20% return over a shorter period than longer.
While the HPR has severe conceptual limits, it provides key information upon which a better model may be constructed. In this section, we will present the calculation for dollar price and return of a bond first, and then for a stock.
