From prices to returns
1. From prices to returns
In this chapter, the core of your analysis will switch from historical prices to historical returns. You'll learn how to compute reward and risk indicators as well as risk-adjusted performance measures.2. What is a financial return?
A return is the amount of money you make, or would potentially make, on an investment. It can be expressed in dollars or in percentages.3. What is a financial return?
The dollar return is the difference between the final value of the investment plus any cash-flow received while holding the investment (like dividends), and the initial value. The percentage return is the dollar return divided by the initial value. For simplicity, we assume no taxes and no trading fees.4. What is a financial return?
In practice, percentage returns are used more often than dollar returns because they allow you to compare different investments.5. What is a financial return?
Let's look at an example. An investor purchases the ABC stock at $100. One year later, they decide to sell the stock at the current market price of $110. During the holding period, they received a dividend of $2. The dollar return is the final value plus the dividend, that is $110 plus $2, minus the initial value of $100. The result is $12. The percentage return can be easily found as $12 divided by $100, that is, 0.12 or 12%.6. Return frequency
Some aspects of our example must be emphasized. First, 12% is a yearly return, because the period between the purchase and the sale of the stock is one year. If it were one month, then the return would be a monthly return. This feature of a percentage return is called "the frequency".7. A series of returns
Second, computing the return does not mean that you have to sell a stock. You can keep track of your investment by calculating the returns at regular intervals (for example each month), and this would represent the potential amount of money made from period to period. All these returns put together lead to a series of historical returns.8. Returns with Google Sheets
Computing a series of returns using spreadsheets is simple. Given a time series of monthly historical prices, you can calculate the percentage return for the first period by applying the formula. In this example, the first return is obtained as the price plus the dividend of February, minus the price of January, divided by the price of January.9. Returns with Google Sheets
Then, you can move the cursor on the bottom right of the cell and wait for a cross to appear.10. Returns with Google Sheets
Once it's there, you click and drag it down to the end of the series. By doing so, you're extending the formula for each cell and thus computing the percentage return for each period.11. Percentage returns
To express the values in percentage, you can either change the format and select "Percent",12. Function TO_PERCENT()
or use the function TO_PERCENT().13. It's time to practice!
Now, it's your turn to compute the historical returns of stock ABC. Time to practice!Create Your Free Account
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