Question

An investor bought a stock for $16 (at t=0) and one year later it paid a $1 dividend (at t=1). Just after the dividend was paid, the stock price was $15 (at t=1). Inflation over the past year (from t=0 to t=1) was -4% pa (note the negative sign), given as an effective annual rate. Which of the following statements is NOT correct? The stock investment produced

a. Nominal capital return of -6.25% pa.
b. Nominal income return of 4.166667% pa.
c. Real capital return of -2.34375% pa.
d. Real income return of 6.510417% pa.
e. Real total return of 4.166667% pa.

Answer 1

The correct statement is d. Real income return of 6.510417% pa.

Step-by-step explanation:

The correct statement is d. Real income return of 6.510417% pa.

Nominal capital return is calculated as the percentage change in the stock price from t=0 to t=1, which is (-1)/16 = -0.0625 or -6.25%.

Nominal income return is calculated as the dividend received at t=1 divided by the stock price at t=0, which is 1/16 = 0.0625 or 6.25%.

Real capital return is calculated by subtracting the inflation rate from the nominal capital return, which is -6.25% - (-4%) = -2.34375%.

Real income return is calculated by subtracting the inflation rate from the nominal income return, which is 6.25% - (-4%) = 10.25%.

Real total return is the sum of the real capital return and real income return, which is -2.34375% + 10.25% = 7.90625% or approximately 4.166667% pa.