FIN 5352 Lecture 7 Chapter 10

You buy a stock for $50. After 1 year, its price rises to $55, and it pays a $2 dividend. You do not sell the stock. Your capital gains yield is _____.

10% ($55 − 50)/$50 = 10%.

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

14% (($114 − 100)/$100 = 14%.)

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% ($114 − 100 + 1)/$100 = 15%.

Suppose you buy a share of stock for $100. At the end of 1 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% ($114 − 100 + 1)/$100 = 15%.

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 1 year, what is the stock's current dividend yield?

2% ($2/$100 = 2%.)

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

5% (5%+5%+5%)3 = 5%.

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 percent

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

7% (8%+2%+11%)3 = 7%.

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

False

The Ibbotson SBBI data shows that ___.

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

Which of the following are true?

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

Which of the following are characteristics of a skewed distribution?

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

What are some important lessons from the 2008 financial crisis?

The stock market is risky and Diversification is important.

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

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

a larger

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

apply to any amount invested

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

arithmetic

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

arithmetic

The dividend yield for a 1-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 average return on the stock market can be used to ___.

compare stock returns with the returns on other securities

The history of U.S. 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

The geometric rate of return takes ______ into account.

compounding

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

direct

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

dividends

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

dividends and capital gains

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

dividends; capital gains

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

equity

The ______ rate of return is the difference between risky returns and risk-free returns.

excess

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

forecast

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 and risk aversion of future investors

If the dispersion of returns on 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 the rate of return over some arbitrary investment period.

holding

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

holding

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

is highly risky

Diversification is commonly used to ___.

lower risk

Percentage returns are ______ dollar returns.

more useful than

Normally, the excess rate of return is ___.

positive

The equity risk _____is the additional return from bearing risk.

premium

The arithmetic average rate of return measures the ____.

return in an average year over a given period

The Sharpe ratio is a measure of ______ to ______.

return; risk

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

returns

The equity risk premium rewards investors for bearing

risk

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

simplifies detailed market data and is the best estimate of any 1 year's stock market return during the specified period

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

small-company stocks had the highest risk level, T-bills, which had the lowest risk, generated the lowest return, and 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 rates of return in the Ibbotson SBBI yearbook are not adjusted for which of the following?

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

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

the arithmetic average return

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

the arithmetic mean minus half of the variance

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

the standard deviation of returns and the mean return

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

transactions costs and taxes

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

variance

A frequency distribution of stock returns displays ____.

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

A probability distribution tends to have a smooth shape when the number of observations is ___.

very large