FIN 357 Chapter 12: Some Lessons from Capital Market History

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The Ibbotson-Sinquefield data shows that ___.

- U.S. T-bills had the lowest risk or variability - long-term corporate bonds had less risk or variability than stocks.

Which of the following are needed to describe the distribution of stock returns?

- standard deviation of returns - mean returns

A projected IRR on a risky investment in the _____ percent range is not unusual.

10 to 20

More volatility in returns produces ______ difference between the arithmetic and geometric averages.

a larger

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 > strong form efficiency strong form efficiency > semistrong form efficiency historical stock prices > historical stock prices

The dividend yield for a 1-year period is equal to the annual dividend amount divided by the ______.

beginning stock price

If you buy a stock for $10 and later sell it for $16, you will have a ____.

capital gain of $6

When a company declares a dividend, shareholders generally receive ______.

cash

The geometric rate of return takes ______ into account.

compounding

The ______ rate of return is the difference between risky returns and risk-free returns.

excess

The (greater/lower) the risk, the greater the required return.

greater

The CPI is the most commonly used measure of _________.

inflation

An efficient market is one that fully reflects all available ______.

information

Stock prices fluctuate from day to day because of _____.

information flow

The excess return on a risky asset is the difference between the risky return and the ____ rate.

risk-free

The geometric average rate of return is approximately equal to ___.

the arithmetic mean minus half of the variance

The square of the standard deviation is equal to the ____.

variance

In an efficient market:

- All investments have NPV=0 - Assets are priced at the present value of their future cash flows

Studying market history can reward us by demonstrating that _____.

-on average, investors will earn a reward for bearing risk -the greater the potential reward is, the greater the risk

Based on average historical returns shown in the text, small-company stocks increased in value by _____ percent in a typical year.

16

Average returns can be calculated using __________ or arithmetic average.

geometric

The Sharpe ratio measures ___.

reward to risk

Some important characteristics of the normal distribution are that it is:

- symmetrical - bell-shaped

Arrange the following investments from highest to lowest return based on what our study of capital market history has revealed about risk premiums.

1. small company common stock 2. long term corporate bonds 3. US T bills

If you are forecasting a few decades in the future (as you might do for retirement planning) you should calculate the expected return using:

Blume's formula

Which of the following is commonly used to measure inflation?

Consumer Price Index

The ___________ ratio is calculated as the risk premium of the asset divided by the standard deviation.

Sharpe

In general, the arithmetic average return is probably too _____ (low/high) for longer periods and the geometric average is probably too _____ (low/high) for shorter periods.

high; low

The year 2008 was _____.

one of the worst years for stock market investors in US history

The second lesson from capital market history is that there is a direct link between __________ and reward.

risk

Geometric averages are ______ arithmetic averages.

smaller than

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 _____ form efficient.

strong

The dividend __________ is defined as the annual dividend amount divided by the beginning stock price.

yield

The Ibbotson-Sinquefield data show that over the long-term, ___.

- small company stocks generated the highest average return - small company stocks had the highest risk level - T bills, which had the lowest risk, generated the lowest return

Arrange the following investments in ascending order from lowest historical risk premium at the top to highest historical risk premium at the bottom.

1. US Treasury Bills 2. Long term corporate bonds 3. Large company stocks 4. Small company stocks

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

True or false: The existence of traders attempting to beat the market is a necessary precondition for markets to become efficient.

True

In an efficient market, firms should expect to receive ______ value for securities they sell.

fair

One way to visually depict the dispersion of returns over a period of time is through a _____.

frequency distribution

The second lesson from studying capital market history is that risk is _____.

handsomely rewarded

An efficient market is one in which any change in available information will be reflected in the company's stock price ___.

immediately

Dividends are the ______ component of the total return from investing in a stock.

income

Based on the historical returns shown in the text, the average __________ was 2.9 percent per year over the 94-year span depicted.

inflation

Based on the historical returns shown in the text, the average ___________ was 2.9 percent per year over the 94-year span depicted.

inflation

Greater return volatility produces a (smaller/larger) difference between the arithmetic and geometric averages.

larger

The standard deviation is the ______ of the variance.

square root

A capital gain on a stock results from an increase in ______.

stock price

Average returns can be calculated _____.

two different ways

The efficient markets hypothesis contends that _____ capital markets such as the NASDAQ are efficient.

well-organized

During the financial crisis of 2008, the S&P 500 Index fell by _____ percent.

37

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

Normally, the excess rate of return on risky assets is ___.

positive

The arithmetic average rate of return measures the ____.

return in an average year over a given period


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