Question 1

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 3 percent, -10 percent, 24 percent, 22 percent, and 12 percent. Suppose the average inflation rate over this time period was 3.6 percent and the average T-bill rate was 4.8 percent. Based on this information, what was the average nominal risk premium?

Accepted Answer

Average return = (0.03 - 0.10 + 0.24 + 0.22 + 0.12)/5 = 0.102Average nominal risk premium = 0.102 - 0.048 = 5.40 percent

Question 2

How can an investor lose money on a stock while making money on a bond investment if there is a reward for bearing risk?
 Aren't stocks riskier than bonds?

Accepted Answer

The answer of How can an investor lose money on...

Question 3

Define and explain the three forms of market efficiency.

Accepted Answer

The answer of Define and explain the three forms of...

Question 4

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 2 percent, -12 percent, 27 percent, 22 percent, and 18 percent. What is the variance of these returns?

Accepted Answer

Average = (0.02 - 0.12 + 0.27 + 0.22 + 0.18)/5 = 0.114Variance = [1/(5 - 1)] [(0.02 - 0.114)² + (-0.12 - 0.114)² + (0.27 - 0.114)² + (0.22 - 0.114)² + (0.18 - 0.114)²] = 0.02588

Question 5

Calculate the standard deviation of the following rates of return:

Accepted Answer

Average return = (0.07 + 0.25 + 0.14 - 0.15 + 0.16)/5 = 0.094Standard deviation = F1F1F1S1F1F1F10 [1/(5 - 1)] [(0.07 - 0.094)² + (0.25 - 0.094)² +(0.14 - 0.094)² +(-0.15 - 0.094)² + (0.16 - 0.094)²] = 15.08 percent

Question 6

You bought one of Great White Shark Repellant Co.'s 10 percent coupon bonds one year ago for $760. These bonds pay annual payments, have a face value of $1,000, and mature 14 years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 14 percent. The inflation rate over the past year was 3.7 percent. What was your total real return on this investment?

Accepted Answer

Nominal return = ($759.92 - $760 + $100)/$760 = 0.13147Real return = [(1 + 0.13147)/(1 + 0.037)] - 1 = 9.11 percent

Question 7

A stock had returns of 12 percent, 16 percent, 13 percent, 19 percent, 15 percent, and -6 percent over the last six years. What is the geometric average return on the stock for this period?

Accepted Answer

Geometric average = (1.12 F1F1F1S1F1F1F10 1.16 F1F1F1S1F1F1F10 1.13 F1F1F1S1F1F1F10 1.19 F1F1F1S1F1F1F10 1.15 F1F1F1S1F1F1F10 0.94)^1/6 - 1 = 11.18 percent

Question 8

Assume that the returns from an asset are normally distributed. The average annual return for the asset is 18.1 percent and the standard deviation of the returns is 32.5 percent. What is the approximate probability that your money will triple in value in a single year?

Accepted Answer

The upper tail of the 99 percent range = 0.181 + (3 F1F1F1S1F1F1F10 0.325) = 1.156 = 115.6 percent, which is less than the 200 percent required to triple your money. Thus, the probability of occurrence is less than 0.5 percent.

Question 9

Shawn earned an average return of 14.6 percent on his investments over the past 20 years while the S&P 500, a measure of the overall market, only returned an average of 13.9 percent. Explain how this can occur if the stock market is efficient.

Accepted Answer

The answer of Shawn earned an average return of 14.6...

Question 10

You find a certain stock that had returns of 4 percent, -5 percent, -15 percent, and 16 percent for four of the last five years. The average return of the stock for the 5-year period was 13 percent. What is the standard deviation of the stock's returns for the five-year period?

Accepted Answer

Return for missing year: 0.04 - 0.05 - 0.15 + 0.16 + x = 0.13 F1F1F1S1F1F1F10 5; x = 65 percentStd dev = F1F1F1S1F1F1F10 [1/(5 - 1)] [(0.04 - 0.13)² + (-0.05 - 0.13)² + (-0.15 - 0.13)² + (0.16 - 0.13)² + (0.65 - 0.13)² = 31.23 percent

Question 11

Suppose a stock had an initial price of $80 per share, paid a dividend of $1.35 per share during the year, and had an ending share price of $87. What was the capital gains yield?

Accepted Answer

Capital gains yield = ($87 - $80)/$80 = 8.75 percent

Question 12

Over the past fifteen years, the common stock of The Flower Shoppe, Inc. has produced an arithmetic average return of 12.2 percent and a geometric average return of 11.5 percent. What is the projected return on this stock for the next five years according to Blume's formula?

Accepted Answer

The answer of Over the past fifteen years, the common...

Question 13

What are the two primary lessons learned from capital market history?
 Use historical information to justify that these lessons are correct.

Accepted Answer

The answer of What are the two primary lessons learned...

Question 14

A stock has a geometric average return of 14.6 percent and an arithmetic average return of 15.5 percent based on the last 33 years. What is the estimated average rate of return for the next 6 years based on Blume's formula?

Accepted Answer

The answer of A stock has a geometric average return...

Question 15

Suppose you bought a 15 percent coupon bond one year ago for $950. The face value of the bond is $1,000. The bond sells for $985 today. If the inflation rate last year was 9 percent, what was your total real rate of return on this investment?

Accepted Answer

Nominal return = ($985 - $950 + $150)/$950 = 0.1947Real return = [(1 + 0.1947)/(1 + 0.09)] - 1 = 9.61 percent

Question 16

Over a 34-year period an asset had an arithmetic return of 13 percent and a geometric return of 10.5 percent. Using Blume's formula, what is your best estimate of the future annual returns over the next 10 years?

Accepted Answer

The answer of Over a 34-year period an asset had...

Question 17

You want to invest in an index fund which directly correlates to the overall U.S. stock market. How can you determine if the market risk premium you are expecting to earn is reasonable for the long-term?

Accepted Answer

The answer of You want to invest in an index...

Question 18

Based on past 26 years, Westerfield Industrial Supply's common stock has yielded an arithmetic average rate of return of 9.63 percent. The geometric average return for the same period was 8.57 percent. What is the estimated return on this stock for the next 4 years according to Blume's formula?

Accepted Answer

The answer of Based on past 26 years, Westerfield Industrial...

Quiz 12: Some Lessons From Capital Market History

How can an investor lose money on a stock while making money on a bond investment if there is a reward for bearing risk? Aren't stocks riskier than bonds?