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Lesson 1 of 10 · 12 min

Financial assets, yields and expected versus actual returns

Every return comes from a price change and from cash paid out, and the return you plan on before investing is never guaranteed to be the one you get.

In short

Financial assets (cash, equity, debt, hybrids) and financial instruments (standardised, tradable contracts such as shares, bonds, rights and derivatives) generate cash flows; financial indicators (exchange rates, interest rates, market indexes) do not and cannot be traded directly.
Total return = price return $(P_1 - P_0)/P_0$ + distribution return $\text{Inc}/P_0$ .
For shares the distribution return is the dividend yield; for bonds it is the current yield: annual coupon ÷ market price.
Expected (ex ante) returns are forecasts made before investing; actual (ex post) returns are what was earned. Risk is the chance that the two differ.
Unrealised (paper) gains become realised when the asset is sold; taxes are usually charged only on realised gains.

Assets, instruments and indicators

A financial asset is a claim with value: cash (coins and notes), an ownership stake (equity), a loan seen from the lender's side (debt), or a hybrid that mixes features of both.

A financial instrument is the standardised, tradable form in which such claims change hands: a listed share, a bond, a subscription right, a derivative contract. Standardisation is what lets investors buy and sell them quickly in markets. Equity and debt are both assets and highly standardised instruments, so the line between the two terms is fine.

A financial indicator is an observable measure of value that you cannot buy and that pays no cash flows: an exchange rate, an interest rate, a market index. You can trade instruments linked to an index, but not the index itself.

Category	Examples	Generates cash flows?	Directly tradable?
Financial asset	Cash, equity, debt, hybrids	Yes (except cash itself)	Not always
Financial instrument	Listed shares, bonds, rights, derivatives	Yes	Yes
Financial indicator	Exchange rates, interest rates, indexes	No	No

Quick test: if it pays you something or you can hold it in an account, it is an asset or instrument. If it is a number you can only observe, it is an indicator.

Two sources of return: price and distributions

The price return (capital appreciation) is the change in price over the period divided by the starting price $P_0$ . The distribution return is the cash paid out during the period, called Inc (dividends, coupons, other distributions), also divided by $P_0$ . Their sum is the total return, the holding period return from the previous lesson.

For shares, the distribution return is the dividend yield: dividends paid in the year divided by the share price at the start of the year.

For bonds, it is the current yield: the annual coupon divided by the bond's market price. When a bond trades above par, its current yield is below its coupon rate; below par, it is above the coupon rate. A bond paying EUR 2.50 per EUR 100 of par and priced at 104.00 has a current yield of 2.40%, not 2.50%.

Some assets earn through one channel only. A share that pays no dividend rewards you only through price; an annuity, which pays a fixed stream of payments, gives no price return to the holder.

The share's total return is mostly price. The bond's coupon (current yield 2.40%) almost exactly offsets its price fall, leaving a total return of about −0.10%.

Expected versus actual returns

An expected return (ex ante) is a forecast made before the outcome is known, built from history, current market conditions and analysis of the asset. Investment decisions are always made on expected returns.

An actual return (ex post) is what the investment earned once the period is over. It can differ from the forecast because of market moves, economic surprises or events specific to the asset.

That gap is the core of risk. The more likely it is that the actual return falls short of the expected one, the more compensation (a larger risk premium) investors demand before they invest. An investment is judged on its ex post outcome, not on the forecast that justified it.

Decisions rest on ex ante returns but deliver ex post returns. The possible gap between them is what a risk premium pays for.

Realised, unrealised and measurement conventions

While you hold an asset, a change in its value is an unrealised return, a paper gain or loss: you would lock it in only by selling at today's price. Once you sell, it becomes a realised return.

Dividends and coupons received while you hold the asset are realised returns, recognised in the period they arrive. In most tax systems, price gains are taxed only when realised, which is why the timing of a sale matters.

Returns can be written as decimals (0.09), fractions (9/100) or percentages (9%). Annual returns are normally measured from the closing price on the last trading day of one year to the last trading day of the next; monthly returns use month-end closing prices the same way.

Notation varies between sources: some use R or i for a return, and some define R as 1 + r. Always check what a symbol means before you plug it into a formula.

Formulas

Price return: $r_{\text{price}} = \dfrac{P_1 - P_0}{P_0}$
$P_0$ = price when the investment is made, $P_1$ = price at the later valuation date.
Distribution return: $r_{\text{distribution}} = \dfrac{\text{Inc}}{P_0}$
Inc = dividends, coupons or other cash distributions in the period. For shares: dividend yield; for bonds: current yield.
Total return: $r = r_{\text{price}} + r_{\text{distribution}} = \dfrac{P_1 - P_0 + \text{Inc}}{P_0}$
The same as the single-period holding period return.
Current yield of a bond: $\text{Current yield} = \dfrac{\text{Annual coupon}}{\text{Market price}}$
Below the coupon rate when the bond trades above par, above it when the bond trades below par.

Worked examples

Example 1 A share's price return and dividend yield

Kestrel Wind ASA closes the year at NOK 240. During the next year it pays a dividend of NOK 6 and ends the year at NOK 282. What are the price return, the dividend yield and the total return?

Example 2 A bond above par

An Alpenbahn AG bond pays an annual coupon of EUR 2.50 per EUR 100 of par. It is priced at 104.00 at the start of the year and 101.40 at the end, after the coupon is paid. Find the price return, the current yield and the total return, and explain why the current yield differs from the 2.5% coupon rate.

Example 3 Realised or unrealised?

Aoife holds 500 shares of Liffey Biotech plc bought at EUR 40. The price is now EUR 46 and she received a EUR 1.20 dividend per share this year. She sells 200 shares at EUR 46. Which gains are realised and which are unrealised?

On the exam

Expect direct calculations of price return, dividend yield or current yield and total return, and concept items on ex ante versus ex post returns, realised versus unrealised gains, and what counts as a financial indicator.

Dividing a bond's coupon by par instead of by its market price when asked for the current yield.
Leaving out the distribution return, or the price return, when asked for the total return.
Treating an expected return as guaranteed: ex ante returns are forecasts, not promises.
Calling an index or an exchange rate a financial instrument; it is an indicator and pays no cash flows.

Check yourself

Q1Which of the following is best described as a financial indicator rather than a financial instrument?
Q2A bond with an annual coupon of 3.00 per 100 of par trades at 96.00. Its current yield is closest to:
Q3For a bond trading above its par value, the current yield is most likely:
Q4A share bought at CHF 80.00 pays a CHF 2.40 dividend and ends the year at CHF 76.00. Its total return is closest to:
Q5Which statement about ex ante and ex post returns is most accurate?
Q6An investor has not sold a share that has risen 30% since she bought it. The 30% is best described as:

0/6Check yourself

Answer the 6 questions: +10 XP for each one you get right first time.

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