Chapter 12

You just sold 600 shares of Wesley, Inc. stock at a price of $31.09 a share. Last year, you paid $30.92 a share to buy this stock. Over the course of the year, you received dividends totaling $1.20 per share. What is your total capital gain on this investment?

$102

West Wind Tours stock is currently selling for $48 a share. The stock has a dividend yield of 2.6 percent. How much dividend income will you receive per year if you purchase 200 shares of this stock?

$249.60

Six months ago, you purchased 100 shares of stock in Global Trading at a price of $38.70 a share. The stock pays a quarterly dividend of $0.15 a share. Today, you sold all of your shares for $40.10 per share. What is the total amount of your dividend income on this investment?

$30

A year ago, you purchased 400 shares of Stellar Wood Products, Inc. stock at a price of $8.62 per share. The stock pays an annual dividend of $0.10 per share. Today, you sold all of your shares for $4.80 per share. What is your total dollar return on this investment?

-$1,488

Four months ago, you purchased 1,500 shares of Lakeside Bank stock for $11.20 a share. You have received dividend payments equal to $0.25 a share. Today, you sold all of your shares for $8.60 a share. What is your total dollar return on this investment?

-$3,525

One year ago, you purchased a stock at a price of $32.16. The stock pays quarterly dividends of $0.20 per share. Today, the stock is selling for $28.20 per share. What is your capital gain on this investment?

-$3.96

A stock had the following prices and dividends. What is the geometric average return on this stock?

-15.21 percent

One year ago, you purchased 200 shares of a stock at a price of $54.18 a share. Today, you sold those shares for $40.25 a share. During the past year, you received total dividends of $164 while inflation averaged 4.2 percent. What is your approximate real rate of return on this investment?

-28.40 percent

A stock has returns of 18 percent, 11 percent, -21 percent, and 6 percent for the past four years. Based on this information, what is the 95 percent probability range of returns for any one given year?

-30.62 to 37.62 percent

What is the amount of the excess return on a U.S. Treasury bill if the risk-free rate is 2.8 percent and the market rate of return is 8.35 percent?

0.00 percent

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 2 percent, -12 percent, 27 percent, 22 percent, and 18 percent. What is the variance of these returns?

0.02588

A stock has an expected rate of return of 13 percent and a standard deviation of 21 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?

0.5 percent

You own 400 shares of Western Feed Mills stock valued at $51.20 per share. What is the dividend yield if your annual dividend income is $352?

1.72 percent

A stock had returns of 12 percent, 16 percent, 13 percent, 19 percent, 15 percent, and -6 percent over the last six years. What is the geometric average return on the stock for this period?

11.18 percent

Over the past fifteen years, the common stock of The Flower Shoppe, Inc. has produced an arithmetic average return of 12.2 percent and a geometric average return of 11.5 percent. What is the projected return on this stock for the next five years according to Blume's formula?

12.00 percent

Over a 34-year period an asset had an arithmetic return of 13 percent and a geometric return of 10.5 percent. Using Blume's formula, what is your best estimate of the future annual returns over the next 10 years?

12.32 percent

Calculate the standard deviation of the following rates of return: 10.79 percent 12.60 percent 13.48 percent 14.42 percent 15.08 percent

15.08 percent

A stock has a geometric average return of 14.6 percent and an arithmetic average return of 15.5 percent based on the last 33 years. What is the estimated average rate of return for the next 6 years based on Blume's formula?

15.36 percent

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

The common stock of Air United, Inc., had annual returns of 15.6 percent, 2.4 percent, - 11.8 percent, and 32.9 percent over the last four years, respectively. What is the standard deviation of these returns?

19.05 percent

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

1978 - 1981

A stock had returns of 11 percent, -18 percent, -21 percent, 5 percent, and 34 percent over the past five years. What is the standard deviation of these returns?

22.60 percent

Last year, you purchased 500 shares of Analog Devices, Inc. stock for $11.16 a share. You have received a total of $120 in dividends and $7,190 from selling the shares. What is your capital gains yield on this stock?

28.85 percent

You find a certain stock that had returns of 4 percent, -5 percent, -15 percent, and 16 percent for four of the last five years. The average return of the stock for the 5-year period was 13 percent. What is the standard deviation of the stock's returns for the five-year period?

31.23 percent

Today, you sold 200 shares of Indian River Produce stock. Your total return on these shares is 5.65 percent. You purchased the shares one year ago at a price of $31.10 a share. You have received a total of $100 in dividends over the course of the year. What is your capital gains yield on this investment?

4.04 percent

A stock had returns of 16 percent, 4 percent, 8 percent, 14 percent, -9 percent, and -5 percent over the past six years. What is the geometric average return for this time period?

4.26 percent

A stock has annual returns of 13 percent, 21 percent, -12 percent, 7 percent, and -6 percent for the past five years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent.

4.60...3.89

One year ago, you purchased a stock at a price of $47.50 a share. Today, you sold the stock and realized a total loss of 22.11 percent. Your capital gain was -$12.70 a share. What was your dividend yield?

4.63 percent

A stock has annual returns of 6 percent, 14 percent, -3 percent, and 2 percent for the past four years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent.

4.75...4.57

The average annual return on small-company stocks was about _____ percent greater than the average annual return on large-company stocks over the period 1926-2007.

5

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 3 percent, -10 percent, 24 percent, 22 percent, and 12 percent. Suppose the average inflation rate over this time period was 3.6 percent and the average T-bill rate was 4.8 percent. Based on this information, what was the average nominal risk premium?

5.40 percent

Last year, you purchased a stock at a price of $47.10 a share. Over the course of the year, you received $2.40 per share in dividends while inflation averaged 3.4 percent. Today, you sold your shares for $49.50 a share. What is your approximate real rate of return on this investment?

6.79 percent

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

6.8 percent

One year ago, you purchased 500 shares of Best Wings, Inc. stock at a price of $9.60 a share. The company pays an annual dividend of $0.10 per share. Today, you sold all of your shares for $15.60 a share. What is your total percentage return on this investment?

63.54 percent

Suppose a stock had an initial price of $80 per share, paid a dividend of $1.35 per share during the year, and had an ending share price of $87. What was the capital gains yield?

8.75 percent

You bought one of Great White Shark Repellant Co.'s 10 percent coupon bonds one year ago for $760. These bonds pay annual payments, have a face value of $1,000, and mature 14 years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 14 percent. The inflation rate over the past year was 3.7 percent. What was your total real return on this investment?

9.11 percent

Based on past 26 years, Westerfield Industrial Supply's common stock has yielded an arithmetic average rate of return of 9.63 percent. The geometric average return for the same period was 8.57 percent. What is the estimated return on this stock for the next 4 years according to Blume's formula?

9.50 percent

Suppose you bought a 15 percent coupon bond one year ago for $950. The face value of the bond is $1,000. The bond sells for $985 today. If the inflation rate last year was 9 percent, what was your total real rate of return on this investment?

9.61 percent

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 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.

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.

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 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 I. The capital gains yield can be positive, negative, or zero. III. The total return can be positive, negative, or zero.

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 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.

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 II. increase in the risk premium III. increase in the 68 percent probability range of the frequency distribution of returns

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 III. relatively high standard deviation IV. relatively large risk premium

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 III. the information has no bearing on the value of the firm IV. the information was anticipated

Which of the following statements are true based on the historical record for 1926-2007? 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 IV. Bonds are generally a safer investment than are stocks.

The historical record for the period 1926-2007 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 1926-2007?

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 statements concerning U.S. Treasury bills is correct for the period 1926-2007?

The annual rate of return was always positive.

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.

Define and explain the three forms of market efficiency.

The current stock price reflects the following information for each form of efficiency: 1. Weak form efficiency: all historical information 2. Semistrong form efficiency: all public and historical information 3. Strong form efficiency: all private, public, and historical information

Which one of the following statements is correct?

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

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 1926-2007?

U.S. Treasury bills

Which one of the following was the least volatile over the period of 1926-2007?

U.S. Treasury bills

Which one of the following statements correctly applies to the period 1926-2007?

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

Which one of the following statements is a correct reflection of the U.S. markets for the period 1926-2007?

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.

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

arithmetic

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 1926-2007. 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 1926-2007?

between 10 and 15 percent

What was the average rate of inflation over the period of 1926-2007?

between 3.0 and 3.5 percent

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

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

A stock had returns of 15 percent, 8 percent, 12 percent, -21 percent, and -4 percent for the past five years. Based on these returns, what is the approximate probability that this stock will return at least 15 percent in any one given year?

greater than 16.0 percent

Your friend is the owner of a stock which had returns of 25 percent, -36 percent, 1 percent, and 16 percent for the past three years. Your friend thinks the stock may be able to achieve a return of 50 percent or more in a single year. Based on these returns, what is the probability that your friend is correct?

greater than 2.5 percent but less than 16 percent

A stock had returns of 14 percent, 13 percent, -10 percent, and 7 percent for the past four years. Which one of the following best describes the probability that this stock will lose no more than 10 percent in any one year?

greater than 84 percent but less than 97.5 percent

Over the past five years, a stock produced returns of 11 percent, 14 percent, 2 percent, - 9 percent, and 5 percent. What is the probability that an investor in this stock will not lose more than 10 percent in any one given year?

greater than 84 percent but less than 97.5 percent

To convince investors to accept greater volatility, you must:

increase the risk premium.

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

Assume that the returns from an asset are normally distributed. The average annual return for the asset is 18.1 percent and the standard deviation of the returns is 32.5 percent. What is the approximate probability that your money will triple in value in a single year?

less than 0.5 percent

A stock had annual returns of 3.6 percent, -8.7 percent, 5.6 percent, and 11.1 percent over the past four years. Which one of the following best describes the probability that this stock will produce a return of 20 percent or more in a single year?

less than 2.5 percent but greater than 1.0 percent

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 while estimates using the historical geometric average will probably tend to _____ the expected return for the short-term.

overestimate...underestimate

The primary purpose of Blume's formula is to:

project future rates of return.

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 1926-2007?

small company stocks

Which one of the following is a correct ranking of securities based on their volatility over the period of 1926-2007? 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 1926-2007?

small-company stocks

Which one of the following earned the highest risk premium over the period 1926-2007?

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.

Efficient financial markets fluctuate continuously because:

the markets are continually reacting to new information.

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