Investment Analysis Identify the Components of Realized Essay

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Investment Analysis

Identify the Components of Realized Return of Common Stock

The real return on the sale of stock is often referred to as the realized return as this is the true rate of return of the risk of investment. Many often mistake the realized return as the gain from the sale of the stock in the secondary market, or at most, the inclusion of dividends that have accrued over the period of ownership. However, as these are indeed components of the formula, the often overlooked area of the return is the tax.

The function of the realized return for common stock in all markets includes the dividend growth model added to the difference between stock purchase price and stock sales price. Therefore, if the stock paid a .10cent dividend on March 31, and the 1000 shares of stock was sold on April 1st, purchased at $20.00 and sold at $30.00, the realized return would be the dividend amount of ten cents multiplied by the 1000 shares sold and again multiplied by the difference between the purchase and selling price ($10.00).

Additionally, the realized return is the amount gained after the exclusion of the capital gains and the ordinary income tax. This is often not included in the definition of realized return, however, tax is indeed relevant to the realized return and is relevant to when an investor decides to sell a stock position. Therefore, the components of a stock's realized return include the dividend yield, the gain (loss) on the sale of stock, and the reduction of tax from the gain.

Contrast Systematic and unsystematic risk

Systematic risk is often associated with the risk that can be 'factored' out or removed via diversification of the portfolio.

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Unsystematic risk, on the other hand, is risk that cannot be 'factored' out or removed from the portfolio and is therefore called market risk. This ostensibly is the portfolio beta and as the broader market (S&P500) moves up/down, the beta is reflective of the unsystematic risk inherent within the portfolio.

Therefore, if the market moves downward 10% and the portfolio beta is 1.8, then the value of the portfolio is expected to reflect a drop in value of approximately 18%. This risk cannot be removed from the portfolio and is generally inherent with investments into emerging markets within a volatile industry, where a fund owns stock in a very stratified area. The relative volatility of the stocks held in such a portfolio can reap huge rewards considering small increases in the market, but can generate major losses given the opposite move or over an extended market decline.

According to Eisenberg & Noe (2001), the underlying function of their formula for systemic risk is to reveal the "measure of systemic risk is based on how many "waves" of defaults are required to induce a given firm in the system to fail." (Eisenberg & Noe, 2001) The idea is the same however, as market risk increases, the level of exposure within the system increases with each portfolio holding having a specific level of systemic risk that correlates to the overall probability of a 'wave' of default, as described by Eisenberg & Noe. Additionally, systematic risk and systemic risk are often used interchangeably by market and risk professionals. In portfolio analysis,….....

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