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Expected Returns

M

Matthew H

Keen member
Hello there,

The general formula for the expected return on any investment is ...
Initial income yield + Expected capital growth

... which can be broken down into ...
Initial income yield + Income growth + Impact of a change in yield

... so Expected capital growth = Income growth + Impact of a change in yield.

I'm struggling to understand the difference between "Income growth" and "Impact of a change in yield". Are you able to help?

Thanks,
Matt
 
Hi

Income growth means the expected increase in income period on period going forwards, eg the expected rate of increase of dividends or rental income

'Impact of a change in yield' refers to the impact of a change in the ratio of income to price (since income yield = income / price).

Effectively, expected capital growth = expected change in price of asset

Since price = income / income yield (just rearranging the equation mentioned above), we can see that the expected change in price will relate to both the expected change in income (ie income growth) and any change in income yield

The statements in the notes aren't robust mathematical relationships, more an explanation of the key drivers - so don't be overly distracted by them

If you do want to delve further then there are various previous threads on this topic (eg https://www.acted.co.uk/forums/index.php?threads/actual-expected-required-returns.12810/) - but I wouldn't recommend it as it is easy to waste a lot of time thinking about these 'equations' without gaining very much in relation to passing the exam!
 
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