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How do you compute short term return from investments?

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Before learning to do that,  we need to understand how percentage works in finance. Let’s catch up with it:

Percentage points:

A percentage point = 1%

Example:
You go to a bank to open a fixed deposit account. The bank says, interest rates have gone up from 8% to 10%. How much is the increase? Is it a 2% rise?

The answer is No. An 8% to 10% rise is 25% rise in interest rates. This is how we calculate it:

  • 10 / 8 = 1.25
  • 1.25 * 100 = 125% or 25 % increase in interest rates.

Another way to say it correctly is – you can say that the interest rates have increased by ‘2 percentage points’.In financial markets, Instead of percentage points, the term used is ‘basis points’. 1 basis point is equal to 1 / 100th of a percentage point.

1 basis point = 1/ 100th of a percentage point    So, 100 basis points = 1 percentage points.

Next time , when the Reserve bank revises the interest rate by ’25 basis points’ , understand that what the bank means Is that it has revised the interest rates by 0.25%.

Here are some questions for you to try out-

  1. A bank is offering a 30% increase in the interest rates on fixed deposit. The old rate is 6%. What is the new rate?
  2. You see an advertisement in paper saying that loan rates have slashed from 12% to 10%. What is the actual drop in loan rates?
  3. The RBI increases rates by 25 basis points. If the old interest rate was 6%, what is the new rate?
  4. A bank cuts interest rates by 125 basis points for the 2rd consecutive month. If the interest is 8 % now, what was the interest 2 months back?
  5. The fixed deposit interest rate has gone up from 8% to 10%. What is the rate of increase in percentage and in percentage points?

Answers:

  1. The old rate is 6%. The increase is 30%. So, the increase in rate is 6* 30% = 1.8%. The new rate would be 7.8%
  2. The loan rates have been slashed fro 12 % to 10%. The decrease in rate is 2 percentage points or 200 basis points or 16.66%
  3. The new interest rate would be 6.25%
  4. The present interest rate is 8%. So, last month the interest rate was 9.25% therefore, 2 months back, the interest rate was 10.50%.
  5. Increase in terms of percentage points = 2 and increase in terms of percentage is 25%

Calculating returns : 

Returns can be calculated from many angles. For short term returns , it’s better to compute simple returns and for long term gains , it’s ideal to use compounded returns. Compounded returns are discussed in our next post.

Calculating simple return:

The formula for computing simple returns   FV  / P  – 1

Where,

  • FV is the amount received on maturity date and
  • P is the amount invested

Example 1

You deposit Rs 10,000 in a bank for a year and gets Rs 11000 in return. The simple return would be –

11,000 / 10,000 – 1 = 0.1 or 10%

Example 2

You purchased 200 shares of ABC Company at 50 per share. You paid Rs 300 as commission to your broker. On a later date, you sell the stock for Rs 75 and pay a commission of Rs 450 to the broker. What is the simple return on investment?

  • Total cost of the share = number of shares x rate + commission paid = Rs 10,300
  • Sale proceeds = number of shares x rate – commission paid =Rs  14550
  • So, the simple return will be as follows:
  • (14550 / 10300) -1   =  (1.41 ) – 1 = .41 or 41%

Example 3

You purchased 200 shares of DEF Company at 50 per share. You paid Rs 300 as commission to your broker. On a later date the company declares dividend of Rs 2 per share. You sell the stock for Rs 75 and pay a commission of Rs 450 to the broker. What is the simple return on investment?

The simple return will be as follows:

  • Total cost = 10,300
  • Total returns = 14,550 + 400 = 14, 950

Simple returns would be

  • (14950 / 10,300) – 1 = 1.45 – 1 = 0.45 or 45%

That’s about simple returns. Remember, simple returns are useful only for short term investments.

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