Chapter 10: Some lessons from capital market history

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

- Strong for efficiency - all information - Semi-strong form efficiency - all public information - Weak form efficiency - historical stock prices

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

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

- variance or standard deviation - mean

In 2008, the S&P 500 plunged ___ %.

37%

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%

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

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

Dividends Capital gains

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

False

True or false: The capital gains yield = (Pt+1 - Pt)/Dt

False

True or false: The geometric average rate of return measures the return in an average year over a given period.

False

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

False

True or false: To get the average return, the yearly returns are summed and then multiplied by the number of returns.

False

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

Geometric averages are usually ______ arithmetic averages.

Smaller

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

True

True or false: The dividend yield = Dt+1/Pt

True

In an efficient market ______ investments have a _____ NPV.

all; zero

To compute the return, the yearly returns are summed and then divided by the number of returns.

average

When a company declares a dividend, shareholders generally receive ____.

cash

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

dividends

The ______ rate of return is the difference between the rate of return on a risky asset and the risk-free rate of return.

excess

Roger Ibbotson and Rex Sinquefield presented year-to-year historical rates of return on types of financial investments.

five

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

handsomely rewarded

Dividends are the ______ component of the total return from investing in a stock.

income

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

information

Stock prices fluctuate from day to day because of:

information flow

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

is highly risky

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

pessimistic

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

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

risk-free

Using capital market history as a guide, it would appear the greatest reward would come from investing in _______.

small-company common stock

The standard deviation is the ______ of the variance.

square root

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

symmetrical bell-shaped

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

the arithmetic mean minus half of the variance

Two ways of calculating average returns are _______ and _______.

the geometric average the arithmetic average

Average returns can be calculated:

two different ways

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

variance

If a study of past stock prices and volume to find mis-priced securities will not lead to gains in the market, then the market must be at least _____ efficient.

weak-form

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

well-organized

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

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

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 _____.

0.5%

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 stocks 3. Long-term corporate bonds 4. Long-term government bonds 5. U.S. Treasury bills

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

1. U.S. Treasury 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%

The standard deviation for large-company stock returns from 1926 to 2017 is:

19.8%

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

2.5%

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

higher

An efficient market is one in which any change in available information will be reflected in the company's stock price ___.

immediately

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

lower; lower greater; greater

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

optimistic