Chapter 10 Fin Policies: Lessons from Market

If you buy 40 shares of BP stock at $35 per share, your total investment in BP is ___.

$1,400

The range of returns for a large stock portfolio. within 2 standard deviations, is _______.

-27.5 and + 51.7%

The range of returns for a large stock portfolio. within 1 standard deviations, is _______.

-7.7 and + 31.9%

The Treasury bills used in the Ibbotson SBBI yearbook had maturities of _______ month(s).

1

If the annual stock market returns for Berry Company were 19 percent, 13 percent, and -8 percent, what was the arithmetic mean for those 3 years?

8% Reason: Mean = (.19 + .13 - .08)/3 = 8%

What are some important lessons from the 2008 financial crisis?

Diversification is important. The stock market is risky.

Which of the following are ways to make money by investing in stocks?

Dividends, Capital gains

True or false: The average return on the stock market can be used to find ways to beat the market.

False

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

The standard deviation of returns The mean return

The two potential ways to make money as a stockholder are through _______ and capital appreciation.

dividends

Normally, the excess rate of return is ___.

positive

The Sharpe ratio is a measure of ______ to ______.

return; risk

The Sharpe ratio measures ___.

reward to risk

If your total dollar return was $7 and your dividend was $2, then the price change on your stock must have been ____.

+$5

From 1900 to 2010, the U.S. equity premium was ___________ %.

7.2

Going back to 1900, the U.S. historical equity risk premium is, on average ___ percent,

7.2

In the _____________ and ______________ study, the large-company common stock portfolio is based on the Standard & Poor's Composite Index.

Blank 1: Ibbotson Blank 2: Sinquefield

Which of the following are true about the stock performance of other countries in 2008?

Iceland's stock prices fell by more than 90 percent. Russia's stock prices fell by more than 50 percent.

The _____________ ratio measures the reward-to-risk.

Sharpe

In the Ibbotson study, the large-company common stock portfolio is based on the ____.

Standard & Poor's Composite Index

Which measure of return is best for making unbiased estimates of future returns?

The arithmetic average return

Which of the following are characteristics of a skewed distribution?

The distribution is not symmetrical The distribution can be skewed to the right or left The mean is not equal to the median

Percentage returns are more convenient than dollar returns because they ____.

apply to any amount invested

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

the arithmetic mean minus half of the variance

An investment of $100, returns 10% in year 1, 15% in year 2, and -20% in year 3. What is your future wealth?

$101.20

If you receive a $2 dividend per share on your 100 shares, your total dividend income is ____.

$200

The long-run average return for large-company common stocks for the period 1926 to 2017 was _____.

12.1%

What is the approximate standard deviation of the returns on an average stock?

50%

The probability of an outcome being within ± two standard deviations of the mean in a normal distribution is approximately ____ percent.

95

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

bell-shaped symmetrical

If you invested $100 and made a total dollar return of $10 over the course of the year, your year-end total cash would be ___.

$110

What will the dividend income be on 1,000 shares of XYZ stock if XYZ distributes a $.20 per share dividend?

$200

What is the maximum capital loss that you can incur if you bought 200 shares of TP Inc. for $32?

$6,400

You buy a stock for $50. After one year, its price rises to $55, and it pays a $2 dividend.. You do not sell the stock. Your capital gains yield is _____.

10% Reason: ($55 - 50)/$50 = 10%

You buy a stock for $100. In one year its price rises to $114, and it pays a $1 dividend. Your capital gains yield is ____.

14%

If stock GHI has an initial price of $100. Two years later the price is $132. What is GHI's geometric mean rate of return?

14.89% Reason: ($132/$100)^1/2 - 1 = 14.89%

In the Ibbotson study, long-term corporate bonds is a portfolio of high-quality corporate bonds with a maturity of:

20 years

The 95.4 percent confidence interval for the historical standard error for the true U.S. equity risk premium should be within ___ percent to ___ percent.

3.4; 11

In 2016, the U.S. stock market capitalization was about ______ trillion.

65

From 1900 to 2010, the U.S. ranked _____ out of 17 countries in terms of having the highest equity risk premium.

7th

Which of the following are true about the stock performance of other countries in 2008?

India's stock prices only fell by more than 50%. Iceland's stock prices fell by more than 90%.

Which of the following positive financial events occurred in the U.S. in 2008?

Long-term bonds had positive returns t-Bills had positive returns

The Ibbotson SBBI small stock portfolio includes the bottom 20% of ______ listed stocks.

NYSE

The Ibbotson SBBI data shows that ___.

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

Which of the following are true?

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

The rates of return in the Ibbotson SBBI yearbook are not adjusted for which of the following?

Transactions costs Taxes

True or false: A capital gain on a stock is counted as part of the total return whether or not the gain is realized from selling the stock.

True

If a stock has returns of 10 percent and 20 percent over 2 years, the geometric average rate of return can be calculated by ____.

[(1.10)(1.20)]^.5 - 1

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

a larger

The ______ mean is the best estimate of next year's return.

arithmetic

The ________ average is used to find the mean of a frequency distribution.

arithmetic

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

beginning stock price

The total dollar return is the sum of dividends and __________.

capital gains or losses

The total dollar return on a stock is the sum of the ____ and the _____.

dividends; capital gains

To ______________ future U.S. equity premiums, assumptions related to the future risk environment and risk aversion of future investors are needed.

forecast

If the dispersion of returns on a particular security is not very spread out from the security's mean return, the security ____.

has a low level of risk

The ______ period rate of return is simply the rate of return over some arbitrary investment period.

holding

The capital gains yield can be found by finding the difference between the ending stock price and the initial stock price and dividing it by the ____.

initial stock price

Diversification is commonly used to ___.

lower risk

Percentage returns are ______ dollar returns.

more useful than

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

The standard deviation is the ______ of the variance.

square root

The Sharpe ratio is the stock's excess return (risk premium) divided by its ____.

standard deviation

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

variance

You bought one share of stock for $100 and received a $2 dividend. If the price of the stock rose to $103, then your total dollar return would be ___.

$5

If you buy 100 shares of ABC stock at $5 per share, your total investment is ___.

$500

The price of XYZ stock rises from $10 to $15. If you own 100 shares, your capital gain is ___.

$500

The price of a stock drops from $50 to $40 per share. If you own 50 shares, your total capital loss is ___.

$500

If the risk premium of stock JKL is 5 percent while the standard deviation is 10 percent, then the Sharpe ratio equals ______.

.5

The Treasury bills used in the Ibbotson SBBI yearbook had maturities of ___.

1 month

One year ago, Ernie purchased shares of RTF common stock for $100 a share. Today the stock paid a dividend of $1 per share. If the stock currently sells for $114 per share, what is Ernie's total return?

15%

Suppose you buy a share of stock for $100. At the end of one year the stock price is $114 and a $1 dividend is paid. If you do not sell the stock, your total annual return is ____.

15%

If stock ABC has a mean return of 10 percent with a standard deviation of 5 percent, then the probability of earning a return greater than 15 percent is about ____ percent.

16 Reason: 15% is 1 SD above the mean. Prob(R>15%) = (1 - .68)/2 = 16%

If stock ABC has a mean return of 10 percent with a standard deviation of 5 percent, then the probability of earning a negative return is approximately ___ percent.

2.5 Reason: 0% is 2 SDs below the mean (0.10-(2*0.05)). Probability of R being more than two standard deviations from the mean is (1 - 0.95), but that means either two standard deviations above or below the mean. The probability of it being 2 standard deviations below the mean, divide by 2 (half are above and half are below in a normal distribution.) 0.05/2 = 2.5%

In 2016, the U.S. stock market represented about ______% of the world stock market capitalization.

42

Going back to 1802, the U.S. historical risk premium is, on average, about ____ percent.

5.4

If the dividend paid over the past year was $2.25 and the beginning stock price was $42 per share, what is the dividend yield?

5.4%

The average stock has a standard deviation of about ____ %.

50%

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

68

What is the arithmetic average return for a stock that had annual returns of 8%, 2% and 11% for the past 3 years?

7%

The historical equity risk premium of US stocks from 1900 to 2010 was:

7.2%

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

7.5%

The long-run average risk premium for large-company common stocks for the period 1926 to 2017 was _____.

8.7%

The average return on the stock market can be used to ___.

compare stock returns with the returns on other securities

The history of US capital market returns is ______ in raw form.

complicated

Geometric averages are usually smaller than arithmetic averages because of the effect of:

compounding

The arithmetic average return ignores ______________

compounding

A ___________ distribution of stock returns plots the frequency of occurrence for various ranges of return.

frequency

Assumptions related to the ____ are critical for forecasting future U.S. equity premiums.

future risk environment risk aversion of future investors

The ____________ period rate of return is the rate of return over some arbitrary investment period.

holding

The equity risk premium rewards investors for bearing ________.

risk

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

risk-free

When dealing with the history of capital market returns, an average stock market return is useful because it ___.

simplifies detailed market data is the best estimate of any one year's stock market return during the specified period

Using the Ibbotson SBBI yearbook, year-by-year real returns can be calculated by ___.

subtracting the annual inflation rate from the annual historical rate of return

Which of the following securities had positive returns in the US in 2008?

t-Bills Corporate bonds Long-term bonds

A frequency distribution of stock returns displays ____.

the frequency of occurrence for each rate of return range various ranges of returns on the horizontal axis

What will your capital gain be if you hold 40 shares of BP stock and the stock price rises from $27 to $40 a share?

$520

An investment of $100, returns 40% in year 1, 30% in year 2, and -50% in year 3. What is your future wealth?

$91.00 Reason: $100 × 1.40 × 1.30 × 0.50 = $91

If the risk premium of stock MNO is 10 percent and the standard deviation is 40 percent, what is the Sharpe ratio?

.25 Reason: Sharpe ratio = .1/.4 = .25

A share of common stock currently sells for $100 and will pay a dividend of $2 at the end of the year. If the price is expected to increase to $113 at the end of one year, what is the stock's current dividend yield?

2%

The probability of a return being more than two standard deviations below the mean in a normal distribution is approximately ___ percent.

2.5

Bonds used in Ibbotson SBBI long-term U.S. government bond portfolio had maturities of __________ years.

20

What is the arithmetic average return for a mutual fund that reported a return of 5% every year for the last 3 years?

5% Reason: Arithmetic average = (5%+5%+5%)/3 = 5%.

If the arithmetic average return is 13% and the variance of returns is 0.08, find the approximate geometric mean.

9%

The __________ average rate of return measures the return in an average year over a given period.

arithmetic

The excess rate of return ____.

can occasionally be negative is generally positive over the long-term

Historically, there is a(n) ______ relationship between risk and expected return in the financial markets.

direct

The ______ risk premium on common stocks represents the additional return from bearing risk.

equity

The average excess return on common stocks is called the ______ risk premium.

equity

The Ibbotson SBBI small stock portfolio includes the bottom _________ of NYSE listed stocks.

fifth Reason: The Ibbotson SBBI small stock portfolio includes the bottom 20% of NYSE listed stocks.

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

is highly risky

The Ibbotson SBBI data presents returns from 1948 to the recent past for ___.

large-company stocks U.S. Treasury bills small-company stocks

The Ibbotson SBBI data presents rates of return from 1948 through recent times for ___.

long-term corporate bonds inflation long-term U.S. government bonds

The equity risk _________ is the additional return from bearing risk.

premium

The equity risk __________ is the additional return from bearing risk.

premium

Your total year-end value from a one-year investment equals the initial investment plus the total dollar return. It also equals the ___.

proceeds from the stock sale plus dividends

The arithmetic average rate of return measures the ____.

return in an average year over a given period

The mean return and the standard deviation of returns can be used to describe the distribution of stock ________

returns