FIN CH 12 Capital markets

If the risk-free rate is 2.2 percent, the inflation rate is 1.9 percent, and the market rate of return is 6.8 percent, what is the amount of the risk premium on a U.S. Treasury bill?

0% Treasury Bill (T-Bill) is risk free asset Therefore there is no risk premium The risk premium on a US Treasury Bill = 0%

For the period 1926-2019, the average risk premium on large-company stocks was about:

8.7 percent

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 of the following yields on a stock can be negative?

Capital gains yield and total return

Which one of the following statements correctly applies to the period 1926-2019?

Long-term corporate bonds outperformed long-term government bonds.

Which one of the following categories of securities had the lowest average risk premium for the period 1926-2019?

U.S. Treasury bills

Which one of the following had the least volatile annual returns over the period of 1926-2019?

U.S. Treasury bills

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

geometric

To convince investors to accept greater volatility, you must:

increase the risk premium.

Which one of the following is a correct ranking of securities based on the volatility of their annual returns over the period of 1926-2019? Rank from highest to lowest.

Long-term government bonds, long-term corporate bonds, intermediate-term government bonds

Which one of the following categories of securities had the highest average annual return for the period 1926-2019?

Small-company stocks

A stock had annual returns of 5.5 percent, −12 percent, and 15.5 percent for the past three years, respectively. What is the standard deviation of returns for this stock?

13.92%

For the period 2009-2019, U.S. Treasury bills had an annual rate of return that was:

between 0 and 2.5 percent.

A stock had annual returns of 7 percent, −28 percent, 13 percent, and 23 percent for the past four years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent

3.75; 1.72 Arithmetic average return 7%-28%+13%+23%/4 = 3.75% Geometric Average return ((1+7%)*(1-28%)*(1+13%) * (1+23%))^1/4-1 = 1.72%

Vanessa purchased a stock one year ago and sold it today for $3.15 per share more than her purchase price. She received a total of $2.60 per share in dividends. Which one of the following statements is correct in relation to this investment?

The capital gains yield is positive.

Which one of the following is the most likely reason why a stock price might not react at all on the day that new information related to the stock's issuer is released? Assume the market is semistrong form efficient.

The information was expected.

Inside information has the least value when financial markets are:

strong form efficient.

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 if the market is efficient.

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

A stock has an expected rate of return of 9.8 percent and a standard deviation of 15.4 percent. Which one of the following best describes the probability that this stock will lose at least half of its value in any one given year?

Less than .5 percent Expected rate of return = 9.8% standard deviation = 15.4% Mean Value = 50% = mean % - expected rate of return / standard deviation (-50%-9.8%)/15.4% = -3.88% less than .5

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

Volatility

Which form of market efficiency would most likely offer the greatest profit potential to an outstanding professional stock analyst?

Weak

An investment earned annual returns of 7 percent, −32 percent, 11.5 percent, and 21.4 percent during the past four years. If you wish to know the compound annual rate of growth that the investment experienced, you should determine the ________, which equals ________ percent.

geometric; −.38 Geometric Average return ((1+7%)*(1-32%)*(1+11.5%) * (1+21.4%))^1/4-1 = -.38%

Individual investors who continually monitor the financial markets seeking mispriced securities:

make the markets increasingly more efficient.

One year ago, you purchased 300 shares of Davis & Saha stock at a price of $29.64 per share. The stock pays an annual dividend of $4.40 per share. Today, you sold all of your shares for $34.60 per share. What is your total dollar return on this investment?

$2,808 Dollar return on investment per share = sell price per share + annual dividend income per share - purchase price per share 34.60 + 4.40 - 29.64 = $9.36 Total dollar return of investment = dollar return of investment per share * # of shares $9.36 * 300 shares = $2,808

One year ago, you purchased a stock at a price of $38.22 per share. Today, you sold the stock and realized a total loss of 11.09 percent on your investment. Your capital loss was −$4.68 per share. What was your dividend yield?

1.15% Total return = -11.09% Market Price = $38.22 Capital loss = -$4.68 Capital Gain Yield = (loss/market price)*100 ($4.68/$38.22)*100 = -12.24% Calculating Dividend Yield: Total return = capital gains yield + Dividend yield -11.09% = -12.24% + Dividend Yield -11.09% + 12.24% = Dividend Yield 1.15% = Dividend Yield

A stock experienced returns of 5 percent, −17 percent, and 15 percent during the last three years. What is the standard deviation of the stock's returns for the three-year period?

16.37% Average Return = (5% - 17% + 15%)/3 = 1% Variance ((5-1)^2+(-17-1)^2+(15-1)^2)/3-1 = (16 + 324 + 196)/2 = 268% Standard Deviation = square root 268 = 16.37%

Suppose you bought a $1,000 face value bond with a coupon rate of 5.6 percent one year ago. The purchase price was $987.50. You sold the bond today for $994.20. If the inflation rate last year was 2.6 percent, what was your exact real rate of return on this investment?

3.65% Coupon received in one year = 5.6% * $1,000 = $56 Annual rate of return = (sales price - buy price + annual coupon)/Buy price =($994.20-$987.50+$56)/$987.50 = 6.35% Based on Fischer's relation: (1 + Nominal rate) = (1 + real rate) * (1 + inflation) (1 + 6.35%) = (1 + Real Rate) * (1 + 2.6%) 1 + Real Return = 1.036544 Real Rate = 3.65%

Last year, you purchased 500 shares of Ayala, Incorporated, stock for $25.20 per share. You have received a total of $400 in dividends and $17,000 in proceeds from selling the shares. What is your capital gains yield on this stock?

34.9% # of shares purchased = 500 Purchase price of share = $25.20 Amount invested in stock = # of shares purchased + purchase price per share 500 * $25.20 = $12,600 Capital Gain Yields on the stock = (amount received from selling the shares - amount of money invested)/amount of money invested * 100 ($17,000-$12,600)/$12,600 * 100 = 34.9%

During the past five years, KwonCo.'s stock earned annual returns of 7 percent, 13 percent, 19 percent, −8 percent, and 15 percent. Suppose the average inflation rate over this time period was 2.6 percent and the average T-bill rate was 3.1 percent. Based on this information, what was the average nominal risk premium?

6.1% Average Nominal Return = Total return/# of year (7 + 13 + 19 - 8 + 15)/5 = 9.20% Risk Free Rate = 3.1% Average nominal risk premium = average nominal return - risk free rate 9.20%-3.1% = 6.10%

You bought one of Carvalho Corporation's 6 percent coupon bonds one year ago for $867. These bonds pay annual payments, have a face value of $1,000, and mature 12 years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 7.4 percent. The inflation rate over the past year was 2.9 percent. What was your total real return on this investment?

6.61% R = 7.4% PMT = -$60 (coupon rate 6% * Face Value $1,000) FV = $-1,000 N = 12 PV = $891.13 (calculate) FV = $891.13 PV = $867.00 PMT = -$60 N = 1 (# of year remaining) I/Y = 9.704122%(Calculate) Real Return = (1 + return) / (1 + inflation) - 1 1.097 / 1.029 = 6.61%

A stock had returns of 3 percent, 12 percent, 26 percent, −14 percent, and −1 percent for the past five years. Based on these returns, what is the approximate probability that this stock will return at least 20 percent in any one given year?

Approximately 16 percent

Which one of the following categories of securities had the most volatile annual returns over the period 1926-2019?

Small-company stocks

Which one of the following earned the highest risk premium over the period 1926-2019?

Small-company stocks

Sung Office Products just announced it is decreasing its annual dividend from $2.20 per share to $1.85 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.

Estimates of the rate of return on a security based on the 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