Appreciation
Appreciation is an increase in the value of an asset, such as stocks, options, currency, bonds and real estate, over a specific period of time. It is the amount by which the selling price of an asset is higher than the initial price. This term also encompasses a rise in the value of an asset held in a company’s accounting book. Appreciation may be driven by a sudden spurt in the demand for an asset, the scarcity of supply of the asset or changes in the inflation rate or the interest rate.
How to Measure Appreciation?
Appreciation in the value of an investment option includes:
# Capital appreciation: This is the difference between the actual sale and the purchase price of a financial asset, such as stocks, options, currency and bonds. For example, if an investor purchases 100 shares of a company for $10 per share and sells the same after 12 months for $10.50 per share, then the capital appreciation is $50 ($0.50 per share).
# Interest amount: Interest is generally paid on capital invested in debt instruments, such as bonds and mutual funds, as well as cash investments, such as savings accounts and certificates of deposit (CD). Interest can be either simple or compound. Simple interest is the interest calculated on the principal amount and does not take into account the time value of money (which refers to inflation/deflation and increases or decreases in the purchasing power of the invested capital). Compound interest is calculated on both the principal and the interest accrued over 12 months.
Interest and capital appreciation together form the total return on investment (ROI). For instance, if a bond is purchased at $20 and pays $2 as interest annually and the bondholder sells the bond for $25 after 12 months, then the ROI is $7 ($5 of capital appreciation and $2 as interest).
Different methods are used to calculate interest in varies types of securities:
* Stock dividends, US mortgages and GIC - Simple interest is calculated.
* Bond yields - compounds interest every six months.
* Bond coupons - are accrued daily and measured as simple rate.
* Stock indexes - Interest compounds annually on the price alone.
* Stocks and mutual funds - compound every time cash flows to/from investors.
* US normal mortgage - interest is measured as simple rate.Download