Question

A stock was trading at $125.10 at the end of year 1. It was trading at the end of year 2 at $118.40 immediately after giving a dividend of $5.00. At the end of year 3. it was trading at $128.60 immediately after giving a dividend of $5.20. Finally, it was trading at $138.70 at the end of year 4 without giving out any dividend. What was the arithmetic average annual return of this stock for the three years between years 1 and 4?

Question 4 options:

	6.18%
	6.34%
	6.50%
	6.66%
	6.83%

Answer 1

- Stock price at year end 1(P1) =$125.10

Stock price at year end 2(P2) =$118.40

Dividend paid during the time = $5

Return in year 2 = [(P2 - P1) + Dividend]/P1

=[($118.40 - $125.10) +$5]/$125.10

= -1.3589%

- Stock price at year end 2(P2) =$118.40

Stock price at year end 3(P3) =$128.60

Dividend paid during the time = $5.20

Return in year 3 = [(P3- P2) + Dividend]/P2

=[($128.60 - $118.40) +$5.20]/$118.40

= 13.0068%

- Stock price at year end 4(P4) =$138.70

Stock price at year end 3(P3) =$128.60

Dividend paid during the time = $0

Return in year 2 = [(P4 - P3) + Dividend]/P3

=[($138.70 - $128.60) +$0]/$128.60

= 7.8538%

Calculating the arithmetic average annual return of this stock for the three years between years 1 and 4:-

Arithmetic Average Annual Return = (Return in year 2 + Return in year 3 + Return in year 4)/3

=(-1.3589% + 13.0068% + 7.8538%)/3

= 6.50%

So, the Arithmetic Average Annual Return is 6.50%

Hence, Option C

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