For most of your life, you will be earning and spending money and it’s rare that the current money income exactly balance with your consumption desires. Most of the time we feel shortage and may be some times we can afford to spend, to avoid this one have to borrow or save to get benefit in the future. When spending is more than the income usually people tends towards saving. Though there are many ways to save but hiding it is not enough as its not worth full and remain same but if you want to enjoy it more than today then you have to invest it somewhere and get the profit in long run. Where as some people don’t meet their ends so that they need to borrow from different sources and pay back in future. The rate of exchange between future consumption (future dollars) and current consumption (current dollars) is the pure rate of interest. It is the exchange rate between future consumption (future dollars) and present consumption (current dollars). Market forces determine this rate. The fact that people are willing to pay more for the money borrowed and lenders desire to receive a surplus on their savings (money invested) gives rise to the value of time referred to as the pure time value of money. If there is devaluation of money in future then the investor demand higher interest rate to cover inflation effect. 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 to provide a risk premium to cover the investment risk Pure Time Value of Money. Investment is the current commitment of dollars for a period of time in order to derive future payments that will compensate the investor for (1) the time the funds are committed, (2) the expected rate of inflation, and (3) the uncertainty of the future payments. There are certain ways and means to invest and the investor who is giving away all his savings should properly check that weather his savings are in safe hands or not and what he will going to achieve in future. The first measure is the historical rate of return on an individual investment over the time period the investment is held (that is, its holding period). Next, we consider how to measure the average historical rate of return for an individual investment over a number of time periods. If you commit $200 to an investment at the beginning of the year and you get back $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). HPR = Ending Value of Investment/Beginning Value of Investment = 220/200
This value will always be zero or greater—that 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. We can change HPR in percentage form to make easier to know the results achieved and easily compare to other investment returns and it is known as Holding Period Yield. HPY = HPR-1
= 0.1 or 10 %
To derive an annual HPY, you compute an annual HPR and subtract 1. Annual HPR is found by: Annual HPR = HPR1/n
Now that we have calculated the HPY for a single investment for a single year, we want to consider mean rates of return for a single investment and for a portfolio of investments. Over a number of years, a single investment will likely give high rates of return during some years and low rates of return, or possibly negative rates of return, during others. Single Investment Given a set of annual rates of return (HPYs) for an individual investment, there are two summary measures of return performance. The first is the arithmetic...