MBA September Intake HEC Paris

Financial Markets Philippe Henrotte

Homework of Lecture 1
Rates & Returns
Generic

answers to be submitted electronically on

www.henrotte.fr
before midnight Sunday 7 October 2018

For Questions 3, 4, 5 and 6, answers in percentage must be entered as numbers with four
decimal precision. If your answer is for instance 12.34%, you should enter 0.1234 being
careful to use the dot as the decimal mark.

Problem 1. Return (3 points)

You invested in a stock a year ago when the share price was EUR 15.00. The net return
over the year was 12.00% and the company has distributed a dividend of EUR 0.75 per
share last year.

Question 1. (1 point) What is the current share price? Give your answer in Euro with
two decimal precision.

Question 2. (1 point) You invested EUR 150,000 a year ago in the stock. How much
dividend did you receive from the company? Give your answer rounded to the nearest
Euro.

Question 3. (1 point) What was the capital gain rate on your investment in the stock last
year?

Problem 2. Compounding (2 points)

Question 4. (1 point) You invest USD 45,000 for ten years and you receive ten years later
USD 200,000. What is the annualized return of your investment?

Question 5. (1 point) You invest CHF 500,000 for one year at the annualized rate of 6.00%
and you then reinvest the proceed for six months at the annualized rate of 8.00%. Which
annualized return have you obtained over one year and a half?

Problem 3. Effective Annual Rate (1 point)

Question 6. (1 point) A bank proposes an investment for two years with an annual
percentage rate of 3.55% compounded quarterly. What is the effective annual rate (or
annually compounding rate) corresponding to this investment?

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 Problem 4. Real Return (1 point)

Question 7. (1 point) You invested GBP 150,000 for 20 years in a portfolio which delivered
a real annually compounded return of 6.50%. Knowing that the annually compounded
inflation for the British pound over the period was 2.30%, what is the value of your portfolio
after 20 years? Give your answer rounded to the nearest pound.

2
MBA September Intake HEC Paris
Financial Markets Philippe Henrotte

Solution to the Homework of Lecture 1

Rates & Returns
October 2018

Problem 1. Return (3 points)

Question 1. (1 point) The net return r1 over the year is given by

P1 + Div1
r1 = −1
P0
from which we derive that

P1 = P0 (1 + r1 ) − Div1 = 15.00 × (1 + 0.12) − 0.75 = 16.05

and the answer is 16.05.

Question 2. (1 point) The number N of shares which you purchased a year ago solves

150,000 = N P0 = N × 15.00

which means that N = 10,000. The dividend received is N Div1 = 10,000 × 0.75 = 7500
and the answer is 7500.

Question 3. (1 point) The capital gain is

P1 16.05
−1= − 1 = 7%
P0 15.00
and the answer is 0.0700.

Problem 2. Compounding (2 points)

Question 4. (1 point) The annualized return r solves

200,000 = 45,000 × (1 + r)10

which means that  1/10

200,000
r= − 1 = 16.087%
45,000
and the answer, with four decimal precision, is 0.1609.

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Question 5. (1 point) We first calculate the amount of Swiss francs which you own through
time. You start with CHF 500,000 and after one year invested at 6% you own

500,000 × (1 + 6%) = 500,000 × 1.06 = CHF 530,000.

You reinvest this amount for half a year at the annualized rate of 8% which means that you
own after a year and a half

530,000 × (1 + 8%)1/2 = 530,000 × 1.081/2 = CHF 550,792.16.

The corresponding annually compounding rate solves

550,792.16 = 500,000 × (1 + r)1.5

since the overall investment covers 1.5 year. We obtain

 1/1.5
550,792.16
r= − 1 = 6.663%
500,000

and the answer, with four decimal precision, is 0.0666.

Problem 3. Effective Annual Rate (1 point)

Question 6. (1 point) Let us assume that we invest one Euro for two years at the annual
percentage rate rAP R of 3.55% compounded quarterly. After one year you receive
 rAP R 4
1+
4
and after two years
 rAP R 8
1+ .
4
The effective annual rate rEAR is the annually compounded rate which delivers the same
value in two years, that is
 rAP R 8
1+ = (1 + rEP R )2 .
4
Solving for rEP R we obtain
 rAP R 4
rEP R = 1 + − 1 = (1 + 3.55%/4)4 − 1 = 3.598%
4
and the answer, with four decimal precision, is 0.0360.

Notice first that the result does not depend on the length of the investment and we would
have obtain the same solution assuming an investment of one year.

Second we remark that the EPR is slightly larger than the quarterly compounded APR
as expected since the EPR compounds once a year when the APR compounds here four
time a year.

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 Problem 4. Real Return (1 point)

Question 7. (1 point) We first derive the nominal rate rnominal from the real rate rreal
and the inflation rate rπ , where all rates are here annually compounded. We know that
1 + rnominal
1 + rreal =
1 + rπ
and therefore

1 + rnominal = (1 + rreal )(1 + rπ ) = (1 + 6.50%)(1 + 2.30%).

After 20 years, your initial investment of GBP 150,000 becomes

150,000 × (1 + rnominal )20 = 150,000 × (1 + 6.50%)20 (1 + 2.30%)20 = 832,906.19

and the answer, rounded to the nearest pound, is 832,906.