After graduating from university last year with a degree in accounting and finance, Jim Hale took a job as a trainee analyst for an investment company in Melbourne. Jim's first few weeks were filled with a series of rotations throughout the firm's various operating units, but this week he was assigned to one of the firm's traders as an analyst. On Jim's first day, his boss called Jim in and told him he wanted to do some rudimentary analysis of the investment returns of the regional airline Regional Express Holdings Ltd (REX). Specifically, Jim was given the following month-end closing prices for the company spanning the months from September 2019 to August 2020:

Questions

1. Compute the monthly realized rates of return earned by REX for the entire year.

2. Calculate the average monthly rate of return for REX, using both the arithmetic and geometric averages.

3. Calculate the year-end price for REX, computing the compound value of the beginning-of-year price of $ 1.11 per share for 12 months at the geometric average monthly rate of return calculated earlier:

End-of-year stock price = Beginning-of-year stock price X (1+ Geometric average monthly rate of return)12

4. Compute the annual rate of return for REX using the beginning share price for the period and the ending price (i.e. $1.11 and $0.82).

Jim was then instructed by his boss to complete the following tasks using the REX price data (note that REX paid no dividend during 2008).

5. Use the geometric average monthly rate of return and the following relationship to calculate the annual rate of return:

Compound annual rate of return= (1+ Geometric average monthly rate of return)12 -1

6. If you were given annual rate of return data for REX or any other company's shares and you were asked to estimate the average annual rate of return an investor would have earned over the sample period by holding the shares, would you use an arithmetic or geometric average of the historical rates of return? Explain your response as if you were talking to a client who has had no formal training in finance or investments.