Final answer:
The rate of return on investment in stocks depends on capital gains/losses and dividends. For stock prices of $23, $25, and $28 at year-end, the returns are 0%, 8%, and 20%, respectively. After adjusting for a 5% inflation rate, the real returns are -5%, 3%, and 15%.
Step-by-step explanation:
To calculate the rate of return on your investment in stocks, you must consider both the capital gains or losses and the dividends received during the period of investment. If you purchase 100 shares at $25 each, your initial investment is $2,500. At the end of the year, the stock pays a $2 per share dividend, leading to a dividend income of $200 (100 shares x $2 per share).
The rate of return for each end-of-year stock price scenario would be as follows:
- (i) If the end-of-year stock price is $23, your capital loss is $200 (100 shares x ($23 - $25)). The total loss including dividends is $0 (capital loss of $200 + dividend income of $200), hence a 0% return.
- (ii) If the end-of-year stock price is $25, your capital gain is $0 (100 shares x ($25 - $25)). The total income including dividends is $200, resulting in an 8% return ([$200/$2,500] x 100).
- (iii) If the end-of-year stock price is $28, your capital gain is $300 (100 shares x ($28 - $25)). The total income including dividends is $500 (capital gain of $300 + dividend income of $200), leading to a 20% return ([$500/$2,500] x 100).
To adjust for inflation, you would subtract the inflation rate from the rate of return. If the inflation rate is 5%, your real rate of return would be:
- (i) -5% (0% return - 5% inflation)
- (ii) 3% (8% return - 5% inflation)
- (iii) 15% (20% return - 5% inflation)
These calculations demonstrate how the rate of return and real (inflation-adjusted) rate of return are determined for stock investments.