FIN 303 CH 10

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

- Dividends - Capital gains

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%

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

Blank 1: mean

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

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

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

higher

Normally, the excess rate of return is ___.

positive

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.

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

- bell-shaped - symmetrical

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

- mean - variance or standard deviation

Two ways of calculating average returns are _______ and _______.

- the geometric average - the arithmetic average

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%

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

2.5%

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 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

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.

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

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

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

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

fair

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

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

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

lower; lower greater; greater

The year 2008 was:

one of the worst years for stock market investors in U.S. history

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

optimistic

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

If a study of a firm's financial information will not lead to gains in the market, then the market must be at least _____ efficient.

semi-strong form

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

small-company common stock

Geometric averages are usually ______ arithmetic averages.

smaller than

The standard deviation is the ______ of the variance.

square root

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

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

variance

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

well-organized

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

Blank 1: 5 or five

The Ibbotson-Sinquefield data shows that:

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

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

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

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

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

False

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

False