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Chapter 1

FIN 501 Chapter Notes - Chapter 1: Dividend, Dividend Yield, The Dominion Bank


Department
Finance
Course Code
FIN 501
Professor
Edward Blinder
Chapter
1

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Chapter 1: A Brief History of Risk and Return
1.1 Returns:
Dollar Returns:
- If you buy an asset of any type, your gain (or loss) from that investment is called the return on
your investment
- This return has 2 components:
1. You may receive some cash directly while you own the investment
2. The value of the asset you purchase may change (you have a capital gain or capital loss on
your investment)
- Ex: You purchased 100 shares of stock in Toronto Dominion Bank on Jan 1st. At that time, TD
was selling for $69 per share, so your 100 shares cost you $6900. At the end of the year, you want
to see how you did with your investment.
o A company may pay cash dividends to its shareholders. As a shareholder in TD, you are a
part owner of the company, and you are entitled to a portion of any money distributes. So if
TD chooses to pay a dividend, you will receive some cash for every share you own.
o In addition to the dividend, the other part of your return is the capital gain or loss on the
stock:
Case 1
Case 2
Ending Stock Price
$74
$65
January 1 value
$6900
$6900
December 31 value
7400
6500
Dividend income
150
150
Capital gain or loss
500
-400
o Over the year, Toronto Dominion pays dividend of $1.50 per share.
Dividend income = $1.50 x 100 = $150
o Case 1: Capital Gain = ($74 - $69) x 100 = $500
o Case 2: Capital Loss = ($65 - $69) x 100 = -$400
o Notice that a capital loss is the same thing as a negative capital gain
o The Total Dollar Return on your investment = the return on an investment measured in
dollars that accounts for all cash flows and capital gains or losses
o Total Dollar Return = Dividend income + Capital gain (or loss)
o Total dollar return = $150 + $500 = $650
o Overall, between the dividends you received and the increase in the price of the stock, the
value of your investment increased from $6900 to $6900 + $650 = $7550
o Suppose you hold on to your TD stock and don’t sell it at the end of the year, you should still
consider the capital gain as part of your return
o The capital gain is every bit as much a part of your return as the dividend and you should
certainly count it as part of your return. The fact that you decide to keep stock and don’t sell
(you don’t “realize” the gain) is irrelevant because you could have converted it to cash if you
had wanted to.
o After all, if you insist on converting your gain to cash, you could always sell the stock and
immediately reinvest by buying the stock back. There is no difference between doing this
and just not selling (assuming that there are no transaction costs or tax consequences from
selling the stock)
o The point is that whether you actually cash out and buy pizzas or continue to hold the
investment doesn’t affect the return you actually earn
Percentage Returns:
- It is usually more convenient to summarize information about returns in percentage terms than in
dollar terms, because that way your return doesn’t depend on how much you actually invested

Only pages 1-2 are available for preview. Some parts have been intentionally blurred.

- With percentage returns the question we want to answer is: How much do we get for each dollar
we invested?
-  
-   
Case 1
Case 2
Ending Stock Price
$74
$65
January 1 value
$69
$69
December 31 value
74
65
Dividend income
1.50
1.50
Capital gain or loss
5
-4
- Dividend Yield = the annual stock dividend as a percentage of the initial stock price
   
Ex: Dividend Yield = $1.50 / $69 = 2.17%
This says that for each dollar we invested we received 2.17 cents in dividends.
- Capital Gain Yield = the change in stock price as percentage of the initial stock price
   
Ex: Capital Gain Yield = (74 69) / 69 = 7.25%
This 7.25 percent yield means that for each dollar invested we got 7.25 cents in capital gains.
- Total Percent Return = the return on an investment measured as a percentage that accounts for
all cash flows and capital gains or losses
2.17 cents in dividends + 7.25 cents in capital gain = 9.42 cents on the dollar or 9.42%
When a return is expressed on a percentage basis, we refer to it as the rate of return or just
return” on the investment.
- Combining the formulas for the dividend yield and capital gains yield, we get a single formula
for the total percentage return:
   
    
- Calculating Percentage Returns Example 1.1- Page 6
1.2 The Historical Record:
Examine year-to-year historical rates of return on 3 important categories of financial investments
These returns can be interpreted as what you would have earned if you had invested in portfolios of the
following asset categories:
1. Large- company stocks. The large-company stock portfolio is based on Toronto’s S&P/TSX 60
Index, which contains 60 of the largest companies (in terms of total market value of outstanding
stock) in Canada.
2. Canada treasury bills. This is a portfolio of Treasury bills (T-bills) with a three-month maturity.
3. Inflation data is obtained as changes in the consumer price indices from the Cansim database.
In addition to year-to-year returns on these financial instruments, the year-to-year percentage changes in
the Consumer Price Index (CPI) are also computed.
The CPI is a standard measure of consumer goods price inflation
A company’s total market capitalization (or market “cap” for short) is equal to its stock price multiplied
by the number of shares of stock
In other words, it’s the total value of the company’s stock
Large companies are often called “large-cap” stocks, and small companies are called “small-cap” stocks
A First Look:
- Figure 1.1: A $1 Investment in Different Types of Portfolios 1983-2007
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