chapter 12 CF notes

Which one of the following statements is TRUE about the historical record from 1926-2010?

Inflation, as measured by the Consumer Price Index, reached double digit levels during some years.

Importance of Financial markets

allow companies, governments and individuals to increase their utility. Also, provide information about returns that are required for various levels of risk

Risk and reward are:

directly related

Total percent return

dividend yield + capital gains yield

Which one of the following categories of securities had the most volatile rates of return over the period 1926-2010?

small-company stocks

Sue wants to invest $2,000 in the common stock of A.B. Ladders & Sons. What should she expect the net present value of this investment to be if the financial markets are efficient?

$0

Capital gains yield

(ending price - beginning price) / beginning price

The highest annual rate of return on long-term government bonds during the period 1926-2010 was between _____ percent:

40 and 50

Efficient Capital Market

A market in which security prices reflect available information

Normal Distribution

A symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard deviation

Geometric Average

Average compound return per period over multiple periods

Greater the volatility

Greater the uncertainty

Total Dollar Return

Income from investment + capital gain (loss) due to price change

Efficient market?

New info comes to market, info analyzed and trades made based on info. Prices should reflect all available public information. If investors stop researching stocks, market not be efficient

Semistrong Form Efficiency

Price reflect all publicly available info including trading info, annual reports, press release. Investors cannot earn abnormal returns by trading on public information. Implies fundamental analysis will not lead to abnormal returns

Weak Form Efficiency

Price reflects all past info such as price and volume. Investors cannot earn abnormal returns by trading on market info. Implies technical analysis will not lead to abnormal returns. Empirical evidence indicates markets generally weak form efficient

Arithmetic Average

Return earned in an average period over multiple periods

Efficient Capital Markets

Stock prices are in equilibrium or "fairly" priced. If true, then you should not be able to earn "abnormal" or "excess" returns. Efficient markets DO NOT imply that investors cannot earn positive return in stock market

Geometric Average Return

The average compound return earned per year over a multiyear period

Variance

The average squared difference between the actual return and the average return

Risk Premium

The excess return required from an investment in a risky asset over that required from a risk-free investment. Treasury bills considered to be risk-free. "extra" return earned for taking on risk

Which one of the following statements is correct?

The higher the standard deviation of returns, the higher the expected risk premium.

Efficient Markets Hypothesis (EMH)

The hypothesis that actual capital markets, such as the NYSE, are efficient

Standard Deviation

The positive square root of the variance

Arithmetic Average Return

The return earned in an average year over a multiyear period

The risk premium is computed as the excess return that a security earns over and above the rate for which one of the following?

U. S. Treasury bill

Which of the following categories of investments had a positive rate of return every year during the period 1926-2010?

U.S. Treasury bills

Dividend yield

income/beginning price

Which one of the following categories of securities had the lowest standard deviation of returns over the period 1926-2010?

intermediate-term government bonds

Variance and standard deviation

measure the volatility of asset returns

Strong Form Efficiency

price reflect all information, including public and private. investors could not earn abnormal returns regardless of info they possess. Empirical evidence indicates markets NOT strong from efficient and insiders could earn abnormal returns

Corporate insiders could NOT benefit financially from the inside information they posses in which type of market?

strong form efficient

Historical variance

sum of squared deviations from the mean / (number of observations - 1)

Geometric average will be Less than arithmetic average

unless all returns are equal