FIN 357 Chapter 12: Some Lessons from Capital Market History
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