The internal and external growth of an organization occurs because of the risk and returns that take place through shareholder investments. Shareholders want to know how much the organization is making and how much they can potentially make in the future. Generally, the returns of shareholders come in two forms. The first part is in the form of dividends which is paid during the year and is known as the income component of the return (Ross et al, 2005). The second part is in the form of capital gain or capital loss on the investment. If the return is given as a percentage return the “capital gain is the change in the price of the stock divided by the initial price” (Ross et al, 2005, p. 237).
The United States has five important financial instruments that yield returns. These financial instruments are the large company common stocks, small company common stocks, long term corporate bonds, long term U.S. Government bonds, and U.S. Treasury Bills (Ross et al, 2005). Stocks offer a higher rate of return than bonds or U.S. Treasury Bills. Investors can measure how much obtained on an investment by figuring out the holding period return, which is “is calculated as the sum of all income and capital growth divided by the value at the beginning of the period being measured” (Investopedia, 2009, para. 1). Additionally, capital market returns maybe summarized using the average return or the series of returns generated over a period of time.
Generally, stocks offer investors risky returns due to the volatility related with the stock market. Risk-free returns, which are associated with Treasury bills and bonds have low-variability returns. According to Ross et al (2005), the “difference between risky returns and risk-free returns is often called the excess return on the risky asset” (p. 246). The excess is the “additional return resulting from the riskiness of common stocks and is interpreted as an equity risk premium” (Ross et al, 2005, p. 246). Using risk...
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