Question

An investor owns a common stock that has been paying a dividend at an annual rate of $2.00. If the investor buys 100 shares of the stock at $50 and sells it 3 months later for $52, the approximate annualized rate of return is:

A)4%.
B)5%.
C)12%.
D)20%.

Answer 1

To calculate the annualized rate of return, we consider both capital gains and dividends received over the holding period and scale it to a yearly basis. The total 3-month return of $250 scales to a 20% annualized rate of return.Hence, the correct answer is option D.

Step-by-step explanation:

The question requires us to calculate the approximate annualized rate of return on an investment in common stock. When the investor buys 100 shares at $50 each, the total investment is $5,000. After 3 months, these shares are sold for $52 each, amounting to $5,200, which generates a profit of $200. Furthermore, the investor would receive a dividend of $0.50 per share for the 3 months ($2.00 annual dividend / 4), adding $50 to the return ($0.50 dividend × 100 shares). Hence, the total return over these 3 months is $250 ($200 capital gain + $50 dividends).

To find the annualized rate of return, we need to scale this 3-month return to a 12-month period:

($250 return / $5,000 initial investment) × (12 months / 3 months) = 0.05 × 4 = 0.20 or 20%.

Thus, the approximate annualized rate of return is 20%, which corresponds to option D.