Chapter 9: Finance Midterm 2

Some important characteristics of the normal distribution are that it is ______.

- bell-shaped - symmetrical

Which of the following are ways to make money by investing in stocks? - interest - capital gains - dividends - amortization

- capital gains - dividends

Arrange the following investments from highest to lowest risk (standard deviation) based on what our study of capital market history from 1926 to 2014 has revealed as shown in Table 10.3. Position 1 of 5 U.S. Treasury bills incorrect toggle button unavailable U.S. Treasury bills

- small company common stock - large company common stock - long term corporate bonds - long term government bonds - US Treasury bills

Studying market history can reward us by demonstrating that ______.

- there is a reward for bearing risk - the greater the potential reward is, the greater the risk

Treasury bills yielded a nominal average return over 95 years of 3.3% versus an average inflation rate of 2.9% over the same period. This makes the real return on Treasury bills approximately equal to ______.

.4%

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

1. US Treasury Bills 2. long-term corporate bills 3. large-company stocks 4. small-company stocks

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

2.5%

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

From 1900 to 2010, the average stock market risk premium of the United States was ______.

7.2%

the arithmetic average return is 10% and the variance of returns is .05, find the approximate geometric mean.

7.5%: .10 - .05/2 = .075 or 7.5%

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%

True or false: From 1900 to 2010, the average stock market risk premium of the United States was the highest of all countries.

False: From 1900 to 2010, the average stock market risk premiums of several countries exceeded that of the United States.

True or false: Arithmetic and geometric averages are useful because they are not influenced by volatility.

False: More volatility in returns produces a greater difference between the arithmetic and geometric averages.

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

False: The arithmetic average rate of return measures the return in an average year over a given period.

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

False: The capital gains yield = (Pt+1 − Pt)/Pt

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

True

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

average

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

direct: Historically, there is a direct (or positive) relationship between risk and expected return in the financial markets.

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

The second lesson from studying capital market history is that risk is ______.

handsomely rewarded

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

higher

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

is highly risky

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

larger

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

lower; lower greater; greater

Normally, the excess rate of return is ______.

positive

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

Two ways of calculating average returns are ______ and ______.

the arithmetic average and the geometric average

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

the arithmetic mean minus half of the variance

Average returns can be calculated ______.

two different ways: arithmetic & geometric

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

variance

The normal distribution is completely described by the ______ and ______.

- variance or standard deviation - mean

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

False: The larger the variance of standard deviation is, the more spread out the returns will be.

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

False: To get the average return, the yearly returns are summed and then divided by the number of returns.

Geometric averages are usually ______ arithmetic averages.

smaller than (because of the effect of compounding)

The standard deviation is the ______ of the variance.

square root