Chapter 12: Some Lessons From Capital Market History
What will the dividend income be on 1000 shares of XYZ stock if XYZ distributes a $0.20 per share dividend?
$200
One year ago, Ernie purchased shares of RTF common stock for $100 a share. Today the stock paid a dividend of $1 per share. If the stock currently sells for $114 per share, what is Ernie's total return?
15%
If the annual stock market returns for Berry Company were 19 percent, 13 percent, and -8 percent, what was the arithmetic mean for those 3 years?
8%
Which of these receive interest? stocks capital gains bonds
bonds
Roger Ibbotson and Rex Sinquefield
conducted studies on rates of return in US financial markets and presented rates on five financial investments; rates can be interpreted as what you would have earned if you had any of the financial invested
standard deviation formula
standard deviation=√(∑(x-mean)^2)/n-1
Kate Corporation has discovered a very secret new product, but hasn't yet announced the discovery to the public. If the stock price reacts before the announcement (assuming no corporate "leaks"), the market is:
strong form efficient
standard deviation
the positive square root of the variance
What is the maximum capital loss that you can incur if you bought 200 shares of TP Inc. for $32?
$6,400
dividend yield formual
(dividend paid on the stock during the year + 1) / price of the stock at the beginning of the year
percentage return formula
(dividends paid at the end of period + change in market value over period) / beginning market value
The Ibbotson-Sinquefield data show that over the long-term, ____________.
-T-bills, which had the lowest risk, generated the lowest return - small-company stocks had the highest risk level - small-company stocks generated the highest average return
two components of percentage return
1. dividend yield 2. capital gains yield
Ibbotson and Sinquefield's 5 financial investments
1. large-company stocks 2. small-company stocks 3. long-term corporate bonds 4. long-term government bonds 5. U.S. Treasury bonds
You buy a stock of $50. After one year, its price rises to $55, and it pays a $2 dividend. You do not sell the stock. Your capital gains yield is ________.
10%
Palmer Company had the following returns: 2013 12% 2014 10% 2015 -8% 2016 4% 2017 22% What is the standard deviation of Palmer's returns?
11.05%
If you are forecasting a few decades in the future you should calculate the expected return using:
Blume's formula
Which of the following is commonly used to measure inflation - The Dow Jones Industrial Average (DJIA) - The CBOE Volatility INdex (VIX) - The Consumer Price Index (CPI) - The Case-Schiller Index (CSI)
The Consumer Price Index (CPI)
arithmetic average return formula
arithmetic average return=∑total return/n=annual stock market returns/n
In an efficient market, firms should expect to receive _______________ value for securities they sell.
fair
return on investment has two components:
income component and capital gain or loss
an efficient market is one that fully reflects all available ___________.
information
The Ibbotson-Sinquefield data shows that _________.
long-term corporate bonds had less risk or variability than stocks U.S. T-bills had the lowest risk or variability
the year 2008 was:
one of the worst years for stock market investors in US history
Bonds used in Ibbotson-Sinquefield's long-term U.S. government bond portfolio had maturities of ___ years.
20
The rates of return in the Ibbotson-Sinquefield studies are not adjusted for which of the following? - inflation - taxes - dividends - bond coupons
- inflation - taxes
Studying market history can reward us by demonstrating that:
- the greater the potential reward is, the greater the risk - on average, investors will earn a reward for bearing risk
normal distribution
A symmetric, bell-shaped curve that is completely defined by its mean and standard deviation
What is the arithmetic average return for a stock that had annual returns of 8%, 2%, and 11% for the past 3 years?
7%
when a company declares a dividend, shareholders generally receive ______________.
cash most dividends are paid in cash
In the Ibbotson-Sinquefield studies, long-term corporate bonds have which of the following characteristics?
- high quality - 20-year maturities
The Ibbotson-Sinquefield data presents rates of return from 1925 to recent times for:
- long-term U.S. government bonds - large-company stocks
The arithmetic average rate of return measures the _______________.
return in an average year over a given period
The Sharpe ratio measures ______________.
reward to risk
The two potential ways to make money as a stockholder are through ________________ and capital appreciation.
dividends
The Ibbotson-Sinquefield data presents returns from 1925 to the recent past for:
U.S. T-bills small cap stocks large cap stocks
When a company declares a dividend, shareholders generally receive __________________.
cash
variance
the average squared difference between the actual return and the average return
the square of the standard deviation is equal to the
variance
If you invested $100 and made a total dollar return of $10 over the course of the year, your rear-end total cash if the stock is sold would be ______________.
$110
Arrange the following investments in ascending order from lowest historical risk premium as the top to highest risk premium at the bottom: long-term corporate bonds large-company stocks small-company stocks U.S. Treasury Bills
U.S. Treasury Bills Long-term corporate bonds Large-company stocks Small-company stocks
-If a stock has returns of 10 percent and 20 percent over 2 years, the geometric average rate of return can be calculated by ___________.
[(1.10)(1.20)]^5-1
______________ were a bright spot for U.S. investors during 2008.
bonds
the total dollar return is the sum of dividends and ______________________.
capital gains and losses
The average return on the stock market can be used to ______________.
compare stock returns with the returns on other securities
total dollar return formula
dividend income + capital gain (or loss)
The __________________ rate of return is the difference between risky returns and risk-free returns.
excess
Which of the following is a conclusion that can be drawn regarding market efficiency from capital market history?
future market prices are hard to predict based on publicly available information
The excess return on a risky asset is the difference between the risky return and the __________ rate.
risk-free
arrange the following investments from highest to lowest return based on what our study of capital market history has revealed about risk premiums. long-term corporate bonds U.S. Treasury bills small company common stock
small-company common stock long-term corporate bonds U.S. Treasury bills
geometric average return
the average compound return earned per year over a multiyear period
risk-free return
the cost of money over time assuming no risk
capital gains yield
the dividend growth rate, or the rate at which the value of an investment grows
risk premium
the excess return required from an investment in a risky asset over that required from a risk-free investment
arithmetic average return
the return earned in an average year over a multiyear period
Total Dollar Return
the return on an investment measured in dollars
If the market changes and stock prices instantly and fully reflect new information, which time path does such a change exhibit?
an efficient market reaction
If you buy 100 shares of ABC stock at $5 per share, your total investment is _____________.
$500
efficient capital market
a market in which security prices reflect available information
In an efficient market:
all investments have NPV=0 assets are priced at the present value of their future cash flows
long term corporate bonds
based on high quality bonds with 20 years to maturity
Historically, there is a(n) _____________ relationship between risk and expected return in the stock market.
direct
capital gains yield formula
(ending price - beginning price) / beginning price
which of the following are true? -on average, T-bills outperform common stocks -common stocks may experience negative returns -T-bills sometimes outperform common stocks -T-bills occasionally show negative returns
- common stocks may experience negative returns - T-bills sometimes outperform common stocks
If the risk premium of stock MNO is 10 percent and the standard deviation is 40 percent, what is the Sharpe ratio?
.25
Palmer Company had the following returns: 2009 12% 2010 10% 2011 -8% 2012 4% 2013 22% What is the variance of Palmer's returns?
0.0122
the probability of an outcome being within ± one standard deviation of the mean in a normal distribution is approximately ___________ percent.
68
return on investment
gain or loss from an investment when you buy an asset
When dealing with the history of capital market returns, an average stock market return is useful because it ___________.
is the best estimate of any one year's stock market return during the specified period simplifies detailed market data
The geometric average rate of return is approximately equal to ____________.
the arithmetic mean minus half of the variance
average returns can be calculated:
two different ways: arithmetic and geometric
The efficient markets hypothesis contends that ________________ capital markets such as the NASDAQ are efficient.
well-organized
You bought one share of stock for $100 and received a 2$ dividend. If the price of the stock rose to $103, then your total dollar return would be _____.
$5
If the risk premium of stock JKL is 5 percent while the standard deviation is 10 percent, then the Sharpe ratio equals.
.5
Look at the frequency distribution in Figure 12.9 and rank the following ranges of stock returns in order from highest to lowest frequency. -10% to 0 0-10% 20%-30% 10%-20%
10%-20% 20%-30% 0-10% -10% to 0
Suppose you buy a share of stock for $100. At the end of one year the stock price is $114 and a $1 dividend is paid. If you do not sell the stock, your total annual return is _____________.
15%
If stock ABC has a mean return of 10 percent with a standard deviation of 5 percent, then the probability of earning a negative return is approximately ___ percent.
16
US Treasury bills
Based on Treasury Bills (T-bills) with a one-month maturity.
Blume's Formula
R(T) = (T-1)/(N-1) x Geometric Average + (N-T)/(N-1) x Arithmetic Average; combines geometric and arithmetic average return
Mona Corporation has a variance of returns of 343, while Scott Corporation has a variance of return of 898. Which company's actual returns vary more from their mean return?
Scott Corporation
large-company stocks
This common stock portfolio is based on the Standard & Poor's (S&P) 500 index, which contains 500 of the largest companies (in terms of total market value of outstanding stock) in the United States.
long term US government bonds
US government bonds with 20 years to maturity
dividend yield
a dividend expressed as a percentage of the beginning stock price
Match each information type to the form of market efficiency that identifies that type of information as being quickly and accurately reflected in stock prices. all information : weak from efficiency all public information : strong form efficiency historical stock prices : semistrong form efficiency
all information : strong form efficiency all public information : semistrong form efficiency historical stock prices : weak form efficiency
A capital gain on a stock results from
an increase in stock price
Percentage returns are more convenient than dollar returns because they __________.
apply to any amount invested
some important characteristics of the normal distribution are that it is:
bell-shaped symmetrical
Which of the following are ways to make money by investing in stocks?
capital gains dividends
dividend income
dividend income=per share dividend*number of shares
The second lesson from studying capital market history is that risk is:
handsomely rewarded
Stock prices fluctuate from day to day because of:
information flow
total cash if stock is sold formula
initial investment + total return
the capital gains yield can be found by finding the difference between the ending stock price and the initial stock price and dividing it by the ___________________.
initial stock price
If the dispersion of returns on a particular security is very spread out from the security's mean return, the security _____.
is highly risky
variance is measured in ___________, while standard deviation is measured in __________.
percent squared; percent
Historically, the real return on Treasury bills has been:
quite low
Geometric averages are ___________ arithmetic averages.
smaller than
small company stocks
smallest 20% of the firms listed on the NYSE
excess return
the additional return we earn by moving from a relatively risk-free investment to a risky one
Blume's formula combines
the arithmetic average return and the geometric average return
income component
the cash you receive directly while you own the investment
efficient markets hypothesis
the hypothesis that actual capital markets, such as the NYSE, are efficient
Total return formula
total return=(ending share price-initial price+dividend)/initial price
A distribution tends to have a smooth shape when the number of observation is _____________________.
very large
capital gain or capital loss
when the value of the asset you purchase changes
What will your capital gain be if you hold 40 shares of BP stock and the stock price rises from $27 to $40 a share?
$520
More volatility in returns produces _____________ difference between the arithmetic and geometric averages.
a larger
the dividend yield for a 1-year period is equal to the annual dividend amount divided by the ___________.
beginning stock price
Which of the following are true about the historical equity risk premiums of the countries studied by Dimson, Marsh, and Staunton?
- Denmark had the lowest equity risk premium - Italy had the highest equity risk premium
Which of the following are true about the historical equity risk premiums of the countries studied by Dimson, Marsh, and Staunton? - the world average equity risk premium was 4.6 percent - the world average equity risk premium was 10.2 percent - Italy had the highest equity risk premium - Denmark had the lowest equity risk premium
- Italy had the highest equity risk premium - Denmark had the lowest equity risk premium
The standard deviation for large-company stock returns from 1926 to 2016 is:
19.9%
some principal findings of financial market research
- trading is more automated and its cost is lower than ever - risky securities, such as stocks, have higher average returns than riskless securities, such as Treasury bills - stocks of small companies have higher average returns than riskless securities, such as Treasury bills - stocks of small companies have higher average returns than those of larger companies - more liquid stocks have higher valuations, but lower returns than less liquid stocks - the cost of capital for a company, project, or division can be estimated using data from the markets