Principles of Finance-Chapter 10

The capital gains yield =

(Pt+1 - Pt)/Pt

If the arithmetic average return is 10% and the variance of returns is 0.05, find the approximate geometric mean.

0.10 - 0.05/2 = 0.075 or 7.5%

The probability of an outcome being at least 2 standard deviations below the mean in a normal distribution is approximately:

2.5%

Treasury Bills yielded a nominal average return over 86 years of 3.5% versus an average inflation rate of 3.0% over the same period. This makes the real return on T-bills approximately equal to _____.

3.5%-3.0%=0.5%

The probability of a return being within ± one standard deviation of the mean in a normal distribution is approximately ___ percent.

68%

2008 was a bad year for markets worldwide. One of the worst hit was the Icelandic Exchange where shares priced dropped _____ in one day.

76%

The dividend yield =

Dt+1/Pt

Which of the following are true based on the year-to-year returns from 1926-2014?

T-bills sometimes outperform common stocks. Common stocks frequently experience negative returns.

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

In an efficient market ______ investments have a _____ NPV.

all; zero

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

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?

dividends capital gains

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

fair

True or false: Because T-bills have low risk relative to common stocks, T-bills cannot outperform common stocks.

false

The second lesson from studying capital market history is that risk is:

handsomely rewarded

historical stock prices =

weak form efficiency

The efficient markets hypothesis contends that _____________ capital markets such as the NYSE are efficient

well organized

The risk-return relationship states that a riskier investment should demand a ____________ return.

higher

The second lesson from studying capital market history states that the _______ the potential reward, the _______ the risk

lower; lower greater; greater

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

the arithmetic mean minus half of the variance

List the following investments starting from lowest historical risk premium to highest historical risk premium.

1. U.S Tresury Bills 2. Long term corporate bonds 3. large company stocks 4. small company stocks

The arithmetic mean for large-company stock returns from 1926 to 2017 is:

12.1%

True or false: The smaller the variance or standard deviation is, the more spread out the returns will be

false

If the dispersion of returns on a particular security is very spread out from the security's mean return, the security ____.

highly risky

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

information

Stock prices fluctuate from day to day because of:

information flow

The normal distribution is completely described by the _______ and ________.

mean variance/standard deviation

If you use an arithmetic average to project long-run wealth levels, your results will most likely be _______.

optimistic

Which type of stock price adjustment time path occurs when there is a bubble (price run up) in the path followed by a decline after the market receives information about the stock?

overreaction and correction

If you use a geometric average to project short-run wealth levels, your results will most likely be _______ .

pessimistic

If you buy an asset of any sort, your gain (or loss) from that investment is called your

return on investment

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

risk free

all public information =

semi-strong form efficiency

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

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

Geometric averages are usually ______ arithmetic averages.

smaller than

Two ways of calculating average returns are _______ and _______.

the arithmetic average the geometric average

Roger Ibbotson and Rex Sinquefield conducted a famous set of studies dealing with rates of return in U.S. financial markets.

true

Average returns can be calculated:

two different ways

Historically, the real return on Treasury bills has been:

quite low

The arithmetic average rate of return measures the ____.

return in an average year over a given period

Arrange the following investments from highest to lowest risk (standard deviation) based on what our study of capital market history from 1926-2014 has revealed as shown in Table 10.3:

1. small company common stock 2. large company common stock 3. long term corporate bonds 4. long term government bonds 5. us treasury bills

two components of return on investments

1. you may receive some cash directly while you own the investment (component of return) 2. the value of the asset you purchase often will change (meaning you have a capital gain/loss on your investment)

To get the average, or _______ , Incorrect Unavailable return, the yearly returns are summed and then divided by the number of returns.

mean

Normally, the excess rate of return is ___.

positive

If a study of a firm's financial information will not lead to gains in the market, then the market must be at least _____ efficient.

semi strong form

all information =

strong form efficiency