FIN 3403 Exam 3 - Conceptual (Ch 12)

What is the probability that small-company stocks will produce an annual return that is more than one standard deviation below the average?

16 percent

Which one of the following time periods is associated with high rates of inflation?

1978-1981

Which one of the following statements is correct concerning market efficiency?

A firm will generally receive a fair price when it issues new shares of stock.

Which one of the following statements is correct? A. The greater the volatility of returns, the greater the risk premium. B. The lower the volatility of returns, the greater the risk premium. C. The lower the average return, the greater the risk premium. D. The risk premium is unrelated to the average rate of return. E. The risk premium is not affected by the volatility of returns.

A. The greater the volatility of returns, the greater the risk premium.

Which one of the following statements best defines the efficient market hypothesis?

All securities in an efficient market are zero net present value investments.

Which one of the following statements related to capital gains is correct?

An increase in an unrealized capital gain will increase the capital gains yield.

The return earned in an average year over a multi-year period is called the _____ average return.

Arithmetic

Which one of the following statements concerning U.S. Treasury bills is correct for the period 1926- 2010? A. The annual rate of return always exceeded the annual inflation rate. B. The average risk premium was 0.7 percent. C. The annual rate of return was always positive. D. The average excess return was 1.1 percent. E. The average real rate of return was zero.

C. The annual rate of return was always positive.

Which of the following statements is correct in relation to a stock investment? I. The capital gains yield can be positive, negative, or zero. II. The dividend yield can be positive, negative, or zero. III. The total return can be positive, negative, or zero. IV. Neither the dividend yield nor the total return can be negative.

I and III only

The historical record for the period 1926-2010 supports which one of the following statements?

It is possible for small-company stocks to more than double in value in any one given year.

Which one of the following statements is correct based on the historical record for the period 1926-2010?

Long-term government bonds had a lower return but a higher standard deviation on average than did long-term corporate bonds.

Which one of the following best defines the variance of an investment's annual returns over a number of years?

The average squared difference between the actual returns and the arithmetic average return.

Stacy purchased a stock last year and sold it today for $3 a share more than her purchase price. She received a total of $0.75 in dividends. Which one of the following statements is correct in relation to this investment?

The capital gains yield is positive.

How can an investor lose money on a stock while making money on a bond investment if there is a reward for bearing risk? Aren't stocks riskier than bonds?

There is a reward for bearing risk over the long-term. However, the nature of risk implies the returns on a high risk security will be more volatile than the returns on a low risk security. Thus, stocks can produce lower returns in the short run. It is the acceptance of this risk that justifies the potential long-term reward.

Which one of the following categories of securities had the lowest average risk premium for the period 1926-2010?

U.S. Treasury bills

Which one of the following was the least volatile over the period of 1926-2010?

U.S. Treasury bills

Which one of the following statements is a correct reflection of the U.S. markets for the period 1926-2010?

U.S. Treasury bills provided a positive rate of return each and every year during the period.

You want to invest in an index fund which directly correlates to the overall U.S. stock market. How can you determine if the market risk premium you are expecting to earn is reasonable for the long-term?

You could compare your expectation to the historical market risk premium for the United States, as well as other industrialized countries, realizing of course, that the future will not be exactly like the past. Nevertheless, this should indicate whether or not your expectation is at least reasonable.

Bayside Marina just announced it is decreasing its annual dividend from $1.64 per share to $1.50 per share effective immediately. If the dividend yield remains at its pre-announcement level, then you know the stock price:

decreased proportionately with the dividend decrease.

To convince investors to accept greater volatility, you must:

increase the risk premium.

The primary purpose of Blume's formula is to:

project future rates of return.

Efficient financial markets fluctuate continuously because:

the markets are continually reacting to new information.

three forms of market efficiency:

-weak form efficiency -semistrong form efficiency -strong form efficiency

The average annual return on small-company stocks was about _____ percent greater than the average annual return on large-company stocks over the period 1926-2010.

5%

According to Jeremy Siegel, the real return on stocks over the long-term has averaged about:

6.7 percent

Shawn earned an average return of 14.6 percent on his investments over the past 20 years while the S&P 500, a measure of the overall market, only returned an average of 13.9 percent. Explain how this can occur if the stock market is efficient.

An investor can purchase securities that have a higher level of risk than the overall market. In an efficient market, these securities will earn a higher return over the long-term as compensation for the assumption of the increased risk. This is the first lesson of the capital markets: There is a reward for bearing risk.

Which one of the following statements correctly applies to the period 1926-2010? A. Large-company stocks earned a higher average risk premium than did small-company stocks. B. Intermediate-term government bonds had a higher average return than long-term corporate bonds. C. Large-company stocks had an average annual return of 14.7 percent. D. Inflation averaged 2.6 percent for the period. E. U.S. Treasury bills had a positive average real rate of return.

E. U.S. Treasury bills had a positive average real rate of return.

What are the two primary lessons learned from capital market history? Use historical information to justify that these lessons are correct.

First, there is a reward for bearing risk, and second, the greater the risk, the greater the potential reward. (As evidence, students should provide a brief discussion of the historical rates of return and the related standard deviations of the various asset classes discussed in the text.)

Which of the following statements related to market efficiency tend to be supported by current evidence? I. Markets tend to respond quickly to new information. II. It is difficult for investors to earn abnormal returns. III. Short-run prices are difficult to predict accurately based on public information. IV. Markets are most likely weak form efficient.

I, II, and III only

If the variability of the returns on large-company stocks were to increase over the long-term, you would expect which of the following to occur as a result? I. decrease in the average rate of return II. increase in the risk premium III. increase in the 68 percent probability range of the frequency distribution of returns IV. decrease in the standard deviation

II and III only

Which of the following correspond to a wide frequency distribution? I. relatively low risk II. relatively low rate of return III. relatively high standard deviation IV. relatively large risk premium

III and IV only

Which two of the following are the most likely reasons why a stock price might not react at all on the day that new information related to the stock issuer is released? I. insiders knew the information prior to the announcement II. investors need time to digest the information prior to reacting III. the information has no bearing on the value of the firm IV. the information was anticipated

III and IV only

Which of the following statements are true based on the historical record for 1926-2010? I. Risk and potential reward are inversely related. II. Risk-free securities produce a positive real rate of return each year. III. Returns are more predictable over the short-term than they are over the long-term. IV. Bonds are generally a safer investment than are stocks.

IV only

weak form efficiency

all historical info

strong form efficiency

all private, public and historical info

semistrong form efficiency

all public and historical info

Assume that you invest in a portfolio of large-company stocks. Further assume that the portfolio will earn a rate of return similar to the average return on large-company stocks for the period 1926-2010. What rate of return should you expect to earn?

between 10 and 12.5 percent

What was the highest annual rate of inflation during the period 1926-2010?

between 10 and 15 percent

What was the average rate of inflation over the period of 1926-2010?

between 3.0 and 3.5 percent

Assume that the market prices of the securities that trade in a particular market fairly reflect the available information related to those securities. Which one of the following terms best defines that market?

efficient capital market

The average compound return earned per year over a multi-year period is called the _____ average return.

geometric

According to theory, studying historical stock price movements to identify mispriced stocks:

is ineffective even when the market is only weak form efficient.

As long as the inflation rate is positive, the real rate of return on a security will be ____ the nominal rate of return.

less than

Individuals who continually monitor the financial markets seeking mispriced securities:

make the markets increasingly more efficient.

The real rate of return on a stock is approximately equal to the nominal rate of return:

minus the inflation rate.

Which one of the following correctly describes the dividend yield?

next year's annual dividend divided by today's stock price

Which one of the following is defined by its mean and its standard deviation?

normal distribution

Estimates of the rate of return on a security based on a historical arithmetic average will probably tend to _____ the expected return for the long-term and estimates using the historical geometric average will probably tend to _____ the expected return for the short-term.

overestimate; underestimate

The excess return is computed as the:

return on a risky security minus the risk-free rate.

Last year, T-bills returned 2 percent while your investment in large-company stocks earned an average of 5 percent. Which one of the following terms refers to the difference between these two rates of return?

risk premium

You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor continually brags to you about the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient.

semistrong

Which one of the following categories of securities had the highest average return for the period 1926-2010?

small company stocks

Which one of the following is a correct ranking of securities based on their volatility over the period of 1926-2010? Rank from highest to lowest.

small company stocks, long-term corporate bonds, intermediate-term government bonds

Which one of the following categories of securities has had the most volatile returns over the period 1926-2010?

small-company stocks

Which one of the following earned the highest risk premium over the period 1926-2010?

small-company stocks

Small-company stocks, as the term is used in the textbook, are best defined as the:

smallest twenty percent of the firms listed on the NYSE.

The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient.

strong

Inside information has the least value when financial markets are:

strong form efficient.

Standard deviation is a measure of which one of the following?

volatility

If you excel in analyzing the future outlook of firms, you would prefer the financial markets be ____ form efficient so that you can have an advantage in the marketplace.

weak

Which one of the following is most indicative of a totally efficient stock market?

zero net present values for all stock investments