What is wealth? Is wealth an intrinsic, tangible thing?

Wealth is not a fixed concept the value of something depends on what someone else is willing to pay for it in a particular point in time. How is it created? How can it be increased? Wealth Humanitys most complex creation. Learn how to manage & grow your wealth.

For most of your life you will be earning & spending money. Income = Consumption (rarely happens) Imbalances will lead you to either borrow or to save to maximize the long run benefit from you income. Income > Consumption = Save the excess You can do several things with your saving Put money in the mattress or bury it in backyard Give up immediate possession of these saving for future larger returns Tradeoff of present consumption for a higher level of future consumption is the reason for SAVING What you do with the saving to make them increase over time is INVESTMENT Consumption > Income = Borrow to make up the difference

Those who give up immediate possession of saving expect to receive in future a greater amount than they gave up. Conversely, those who consume more than their current income must be willing to pay back in the future more than they borrowed. Both peoples willingness to pay this difference for borrowed funds and their desire to receive a surplus on their saving give rise to an interest rate referred to as pure time value of money. This interest rate is established in capital market by a comparison of the supply of excess income (saving) to be invested & the demand for excess consumption (borrowing) at any given time.

Example1: If you can exchange Rs. 100 of certain income today for Rs.104 of certain income 1 yr from today, then the pure rate of interest on a risk-free investment (i.e. the time value of money) is said to be 4 % (104/100 1). The investor who gives up Rs.100 today expects to consume Rs.104 of goods & services in the future. Assumption = No change in price level This price stability has rarely been the case during the past several decades when inflation rates have increased. If investors expect a change in prices (i.e. inflation), they will require a higher rate of return to compensate for it. If an investor expects a rise in prices at the rate of 2 % during the period of investment, he or she will increase the required interest rate by 2 %. The investor would require Rs.106 in the future to defer the Rs.100 of consumption during an inflationary period. Further, if the future payment from the investment is not certain, the investor will demand an interest rate that exceeds the pure time value of money plus the inflation rate. The uncertainty of the payments from an investment is the investment risk. The additional return added to the nominal, risk-free interest rate is called a risk premium.

An investment is the current commitment of rupees for a period of time in order to derive future payments that will compensate the investor for
the time the funds are committed, the expected rate of inflation, and the uncertainty of the future payments.

The investor can be an individual, a government, a pension fund, or a corporation. Similarly, this definition includes all types of investments, including investments by corporations in plant & equipment & investments by individuals in stocks, bonds, commodities, or real estate. In all cases, the investor is trading a known rupee amount today for some expected future stream of payments that will be greater than the current outlay.

Investment = Defer current consumption in order to add to our wealth so that we can consume more in the future Why should we compute mean rate of return. Compare investment (e.g. Rs100 = No Dividend or Rs. 150 that pays Rs. 5 as dividend per year) Change in wealth resulting from this investment = cash inflows (interest or dividends), or change in the price of the asset (+ve or -ve). Example2:If you commit Rs.200 to an investment at the beginning of the year & you get back Rs. 220 at the end of the year, what is your return for the period? The period during which you own an investment is called its holding period, and the return for that period is the holding period return (HPR).

Holding Period Return (HPR) = Ending Value of Investment/Beginning Value of Investment HPR = Rs. 220 / Rs. 200 = 1.10 Example3: If you commit Rs.500 to an investment at the beginning of the year & you get back Rs. 400 at the end of the year, what is your return for the period? HPR = Ending Value of Investment/Beginning Value of Investment HPR = 400 / 500 = 0.80 The value of HPR will always be zero or greaterthat is, it can never be a negative value. A value greater than 1.0 reflects an increase in your wealth, which means that you received a positive rate of return during the period. A value less than 1.0 means that you suffered a decline in wealth, which indicates that you had a negative return during the period. An HPR of zero indicates that you lost all your money.

HPR = change in value of an investment However an investor would like to evaluate returns in % terms on an annual basis so that it is easier to directly compare alternative investments that have different risk characteristics. Holding Period Yield (HPY) = HPR minus 1 HPY = 1.10 1 = 0.10 = 10 % To derive an annual HPY, you compute an annual HPR and subtract 1 Annual HPR = HPR1/n n = number of years the investment is held

Problem1: Consider an investment that cost Rs. 250 and is worth Rs. 350 after being held for 2 years. HPR = Ending Value of Investment / Beginning Value of Investment HPR = 350 / 250 = 1.40 Annual HPR = (1.40)1/n (n = 2 years) = (1.40)1/2 = 1.1832 Annual HPY = 1.1832 1 = 0.1832 = 18.32% Problem2: Consider an investment that cost Rs. 1000 and is worth Rs. 750 after being held for 2 years. HPR = 750 / 1000 = 0.75 Annual HPR = (0.75)1/n (n = 2 years) = (0.75)1/2 = 0.866 Annual HPR = 0.866 1 = -0.134 = -13.4% Problem3: Consider an investment of Rs.100 held for only 6 months that earned a return of Rs.12. HPR = 112 / 100 = 1.12 (n=0.5) Annual HPR = (1.12)1/n = (1.12)1/0.5 = 1.2544 Annual HPY = 1.2544 -1 = 0.2544 = 25.44%

Problem 4: On February 1, you bought 100 shares of a stock for Rs.34 a share. The par value of each share is Rs. 10. A year later you sold it for Rs.39 a share. During the year, you received dividend at 15%. Compute your HPR & HPY on this stock investment. Problem 5: On March 15, you purchased 100 shares of a stock at Rs.65 a share & a year later you sold it for Rs.61 a share. During the year, you received dividends of Rs.3 a share. Compute your HPR & HPY on this investment. Problem 6: At the beginning of last year, you invested Rs.4,000 in 80 shares of the Champion Corp. During the year, Champion paid dividends of Rs.5 per share. At the end of the year, you sold the 80 shares for Rs.59 a share. Compute your total HPY on these shares & indicate how much was due to the price change & how much was due to the dividend income. Problem 7: Compute total return & determine how much is attributed to dividend income & how was due to price change? Price at the beginning of the year = Rs. 60.00 Dividend Paid at the end of year = Rs. 2.40 Price at the end of the year = Rs. 69.00

So far we have calculated the HPY (Capital Gain + Dividend Yield) for a single investment for a single year. Now we will discuss mean rates of return for a single investment & for a portfolio of investments. Over a number of years, your investment will likely give high rates of return during some years & low rates of return, or possibly negative rates of return, during others. As an investor your analysis should consider each of these returns in order to understand what you will receive if you own this investment, for this you need a summary (final) figure that indicates this investments rate of return over some period of time.

Arithmetic Mean (AM) - a measure of mean return equal to the sum of annual HPYs (Capital Gain + Dividend Yield) divided by the number of years. AM = HPY/n Geometric Mean (GM) - the nth root of the product of the annual holding period returns for n years, minus one (1). GM = [ HPR]1/n - 1 where: = the product of the annual holding period returns, i.e., (HPR1) x (HPR2) ... (HPRn) Problem 8: Calculate AM & GM?
YEAR 1 2 3 BEGINNING VALUE 100 115 138 ENDING VALUE 115 138 110.40 HPR 1.15 1.20 HPY 0.15 0.20

0.80 -0.20