Capital Appreciation Definition
Capital appreciation is defined as an increase in an asset’s value due to an increase in its market price. In simpler terms, the asset is worth more than its original purchase price, and can be resold at a profit if desired. Capital appreciation can be demonstrable, as in the case of stocks which can be sold for a higher amount than their purchase price at a given point in time. Projected capital appreciation is the theoretical ability of an asset to increase in value over the course of months or years. Capital appreciation refers only to the resale worth of the asset, not its ability to produce interest or dividends for its owners.
Capital Appreciation Bonds
Capital appreciation bonds are financial securities that have a defined value at maturity, but pay no interest to the owner until maturity. Also known as zero-coupon bonds or accrual bonds, these securities are bought at a fraction of their face value. Interest earned on the initial investment is reinvested, compounding the interest until the face value of the bond is met. Fixed interest rates guarantee a return on the initial investment, but will not increase if overall interest rates rise. This makes investment in capital appreciation bonds a bearish strategy, since the investor is essentially betting that the interest rate will remain steady or fall, rather than rise beyond the interest rate available at the time of purchase. As a result, these bonds are among the most volatile securities on the market, fluctuating in value inversely with the general economic forecast.
Capital Appreciation Fund
Some mutual funds are designed to produce profits mainly through purchasing securities expected to increase in value; these funds are known as capital appreciation funds or aggressive growth funds. By focusing on the projected capital appreciation of various securities, rather than the likely future dividends, capital appreciation fund managers generally make aggressive, risky investments designed to maximize profits. In contrast to capital appreciation bonds, these funds are considered bullish, since profits increase with upswings in the market overall. Essentially, investors are betting that the value of the securities purchased will go up, creating a profit either in the short-term or over the long run. One attraction of capital appreciation funds is the lessened tax liability they present; capital gains are generally taxed at a lower rate than interest or dividend income in order to encourage economic investment over the long term.
Calculating Capital Appreciation Value
While extremely complex algorithms are used to project the probable capital appreciation of securities, deriving the actual raw capital appreciation value is fairly simple. A typical capital appreciation calculator uses the following equation:
Capital appreciation = (gross rate of return) – (initial investment cost) – (yield).
This derives a raw figure for capital appreciation at the time of sale; it does not include ongoing cost figures or tax liabilities. While capital appreciation generally offers more risk than dividend-based investments, it also offers greater opportunities for profit than dividend income. For investors concerned with maximizing their return on investment, a mix of capital appreciation bonds and funds can offer a diversified portfolio and mitigate some of the risk involved.