Sie sind auf Seite 1von 49

Chapter 10 - Some Lessons from Capital Market History

Chapter 10 Some Lessons from Capital Market History Answer Key

Multiple Choice Questions

1. Investors require a 4 percent return on risk-free investments. On a particular risky


investment, investors require an excess return of 7 percent in addition to the risk-free rate of 4
percent. What is this excess return called?
A. Inflation premium
B. Required return
C. Real return
D. Average return
E. Risk premium

Refer to section 10.3.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.3
Topic: Risk premium

10-1
Chapter 10 - Some Lessons from Capital Market History

2. The variance is the average squared difference between which of the following?
A. Actual return and average return
B. Actual return and (average return/N - 1)
C. Actual return and the real return
D. Average return and the standard deviation
E. Actual return and the risk-free rate

Refer to section 10.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Variance

3. Which one of the following is the positive square root of the variance?
A. Standard deviation
B. Mean
C. Risk-free rate
D. Average return
E. Real return

Refer to section 10.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Standard deviation

10-2
Chapter 10 - Some Lessons from Capital Market History

4. Which one of the following is defined as a bell-shaped frequency distribution that is


defined by its average and its standard deviation?
A. Arithmetic average return
B. Variance
C. Standard deviation
D. Probability curve
E. Normal distribution

Refer to section 10.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Normal distribution

5. Which one of the following is defined as the average compound return earned per year over
a multiyear period?
A. Geometric average return
B. Variance of returns
C. Standard deviation of returns
D. Arithmetic average return
E. Normal distribution of returns

Refer to section 10.5.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Geometric average return

10-3
Chapter 10 - Some Lessons from Capital Market History

6. Which one of the following best describes an arithmetic average return?


A. Total return divided by N - 1, where N equals the number of individual returns
B. Average compound return earned per year over a multiyear period
C. Total compound return divided by the number of individual returns
D. Return earned in an average year over a multiyear period
E. Positive square root of the average compound return

Refer to section 10.5.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Arithmetic average return

7. An efficient capital market is best defined as a market in which security prices reflect
which one of the following?
A. Current inflation
B. A risk premium
C. Available information
D. The historical arithmetic rate of return
E. The historical geometric rate of return

Refer to section 10.6.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Efficient capital market

10-4
Chapter 10 - Some Lessons from Capital Market History

8. Which one of the following is the hypothesis that securities markets are efficient?
A. Geometric market hypothesis
B. Standard deviation hypothesis
C. Efficient markets hypothesis
D. Capital market hypothesis
E. Financial markets hypothesis

Refer to section 10.6.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Efficient Market Hypothesis

9. Which one of the following combinations will always result in an increased dividend
yield?
A. Increase in the stock price combined with a lower dividend amount
B. Increase in the stock price combined with a higher dividend amount
C. Decrease in the stock price combined with a lower dividend amount
D. Decrease in the stock price combined with a higher dividend amount
E. Increase in the stock price combined with a constant dividend amount

Refer to section 10.1

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Dividend yield

10-5
Chapter 10 - Some Lessons from Capital Market History

10. Which one of the following could cause the total return on an investment to be a negative
rate?
A. Constant annual dividend amount
B. Increase in the annual dividend amount
C. Stock price that remains constant over the investment period
D. Stock price that declines over the investment period
E. Stock price that increases over the investment period

Refer to section 10.1.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Total return

11. Which one of the following statements is correct concerning both the dollar return and the
percentage return on a stock investment?
A. The dollar return is dependent on the size of the investment while the percentage return is
not.
B. The dollar return is more accurate than the percentage return because the dollar return
includes dividend income while the percentage return does not.
C. The dollar return considers the time value of money while the percentage return does not.
D. Dollar returns are based on capital gains while percentage returns are based on the total
rate of return.
E. Dollar returns must either be zero or a positive value while percentage returns can be
negative, zero, or positive.

Refer to section 10.1.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Dollar and percentage returns

10-6
Chapter 10 - Some Lessons from Capital Market History

12. Percentage returns:


I. are easy to understand.
II. relay information about a security more easily than dollar returns do.
III. are not affected by the amount of the investment.
IV. can be easily separated into dividend yield and capital gain yield.
A. II and III only
B. I and III only
C. I, II, and III only
D. I, II, and IV only
E. I, II, III, and IV

Refer to section 10.1.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Percentage returns

13. One year ago, you purchased 100 shares of a stock .This morning you sold those shares
and realized a total return of 8.2 percent. Given this information, you know for sure the:
A. stock price increased by 8.2 percent over the last year.
B. stock increased in value over the past year.
C. stock paid a dividend.
D. dividend yield is greater than zero.
E. sum of the dividend yield and the capital gains yield is 8.2 percent.

Refer to section 10.1.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Total return

10-7
Chapter 10 - Some Lessons from Capital Market History

14. The historical returns on large-company stocks, as reported by Ibbotson and Sinquefield
and reported in your textbook, are based on the:
A. largest 20 percent of the stocks traded on the NYSE.
B. stock returns for the largest 10 percent of the publicly traded firms in the U.S.
C. returns of the 100 largest firms in the U.S.
D. returns of all of the stocks listed on the NYSE.
E. stocks of the 500 companies included in the S&P 500 index.

Refer to section 10.2.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.2
Topic: Historical returns

15. Over the period of 1926-2008, which one of the following investment classes had the
highest volatility of returns?
A. Large-company stocks
B. U.S. Treasury bills
C. Small-company stocks
D. Long-term corporate bonds
E. Long-term government bonds

Refer to section 10.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Historical volatility of returns

10-8
Chapter 10 - Some Lessons from Capital Market History

16. Over the period of 1926-2008:


A. long-term government bonds underperformed long-term corporate bonds.
B. small-company stocks underperformed large-company stocks.
C. inflation exceeded the rate of return on U.S. Treasury bills.
D. U.S. Treasury bills outperformed long-term government bonds.
E. large-company stocks outperformed all other investment categories.

Refer to section 10.3.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Historical returns

17. Over the period of 1926-2008:


A. the risk premium on large-company stocks was greater than the risk premium on small-
company stocks.
B. U.S. Treasury bills had a risk premium that was just slightly over 2 percent.
C. the risk premium on long-term government bonds was zero percent.
D. the risk premium on stocks exceeded the risk premium on bonds.
E. U. S. Treasury bills had a negative risk premium.

Refer to section 10.3.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Risk premium

10-9
Chapter 10 - Some Lessons from Capital Market History

18. The rate of return on which one of the following is used as the risk-free rate?
A. Long-term government bonds
B. Long-term corporate bonds
C. Inflation, as measured by the Consumer Price Index
D. U.S. Treasury bill
E. Large-company stocks

Refer to section 10.3.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Risk-free rate

19. Which one of the following had the lowest standard deviation of returns for the period of
1926 - 2008?
A. U.S. Treasury bill
B. Inflation
C. Long-term corporate bonds
D. Large-company stocks
E. Long-term government bonds

Refer to section 10.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Historical risk

10-10
Chapter 10 - Some Lessons from Capital Market History

20. Which one of the following categories has the widest frequency distribution of returns for
the period 1926-2008?
A. Small-company stocks
B. U.S. Treasury bills
C. Long-term government bonds
D. Inflation
E. Large-company stock

Refer to section 10.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Historical risk

21. The period 1926-2008 illustrates that U.S. Treasury bills:


A. outperform inflation by approximately 1 percent every year.
B. have a zero standard deviation.
C. can either outperform or underperform inflation on an annual basis.
D. produce a rate of return roughly equivalent to the rate of return on long-term government
bonds.
E. routinely have negative annual returns.

Refer to section 10.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.4.
Topic: Historical returns

10-11
Chapter 10 - Some Lessons from Capital Market History

22. The historical record for the period 1926-2008 shows that the annual nominal rate of
return on:
A. risk-free securities has averaged around 5 percent.
B. the Consumer Price Index has been positive every year.
C. U.S. Treasury bills have had a positive rate of return for every year in the period.
D. U.S. Treasury bills is constant.
E. large company stocks has averaged around 9 percent.

Refer to section 10.3.

Bloom's: Knowledge
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.3
Topic: Historical returns

23. What was the average annual risk premium on small-company stocks for the period 1926-
2008?
A. 5.3 percent
B. 6.2 percent
C. 8.5 percent
D. 12.6 percent
E. 15.3 percent

Refer to section 10.3.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.3
Topic: Historical risk premium

10-12
Chapter 10 - Some Lessons from Capital Market History

24. Based on the period 1926-2008, what rate of return should you expect to earn over the
long-term if you are unwilling to bear risk?
A. Between 0 and 1 percent
B. Between 1 and 2 percent
C. Between 2 and 3 percent
D. Between 3 and 4 percent
E. Between 4 and 5 percent

Refer to section 10.3.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Historical returns

25. Which one of the following statements is true regarding the period 1926-2008?
A. The returns on small-company stocks were less volatile than the returns on large-company
stocks.
B. The risk-free rate of return remained constant over the time period.
C. U.S. Treasury bills had a positive average real rate of return.
D. Bonds had an average rate of return that exceeded the average return on stocks.
E. The inflation rate was just as volatile as the return on long-term bonds.

Refer to section 10.4.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments and 10-03 Explain the historical risks on
various important types of investments
Section: 10.4
Topic: Historical risk and returns

10-13
Chapter 10 - Some Lessons from Capital Market History

26. For the period 1926-2008, which one of the following had the smallest risk premium?
A. Large-company stocks
B. Small-company stocks
C. Long-term corporate bonds
D. U.S. Treasury bills
E. Long-term government bonds

Refer to section 10.3.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.3
Topic: Risk premium

27. Which one of the following statements is correct?


A. The risk-free rate of return has a risk premium of 1.0.
B. The reward for bearing risk is called the standard deviation.
C. Risks and expected return are inversely related.
D. The higher the expected rate of return, the wider the distribution of returns.
E. Risk premiums are inversely related to the standard deviation of returns.

Refer to sections 10.3 and 10.4.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.3 and 10.4
Topic: Risk and return

10-14
Chapter 10 - Some Lessons from Capital Market History

28. Which one of the following is the most apt to have the largest risk premium in the future
based on the historical record for 1926-2008?
A. U.S. Treasury bills
B. Large-company stocks
C. Long-term government debt
D. Small-company stocks
E. Long-term corporate debt

Refer to section 10.3.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Risk premium

29. The average risk premium on long-term government bonds for the period 1926-2008 was
equal to:
A. zero.
B. one percent.
C. the rate of return on the bonds plus the corporate bond rate.
D. the rate of return on the bonds minus the T-bill rate.
E. the rate of return on the bonds minus the inflation rate.

Refer to section 10.3.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Risk premium

10-15
Chapter 10 - Some Lessons from Capital Market History

30. The lower the standard deviation of returns on a security, the _____ the expected rate of
return and the _____ the risk.
A. lower; lower
B. lower; higher
C. higher; lower
D. higher; higher
E. You cannot determine anything about the expected rate of return from the standard
deviation.

Refer to section 10.4.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Standard deviation of returns

31. The standard deviation measures the _____ of a security's returns over time.
A. average value
B. frequency
C. volatility
D. mean
E. arithmetic average

Refer to section 10.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Standard deviation

10-16
Chapter 10 - Some Lessons from Capital Market History

32. Which one of the following has the narrowest distribution of returns for the period 1926-
2008?
A. Long-term corporate bonds
B. Long-term government bonds
C. Intermediate-terms government bonds
D. Large-company stocks
E. Small-company stocks

Refer to section 10.4.

Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Return distributions

33. What is the probability associated with a return that lies in the upper tail when the mean
plus two standard deviations is graphed?
A. 0.05 percent
B. 0.5 percent
C. 1.0 percent
D. 2.5 percent
E. 5.0 percent

Refer to section 10.4.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Probability range

10-17
Chapter 10 - Some Lessons from Capital Market History

34. When, if ever, will the geometric average return exceed the arithmetic average return for a
given set of returns?
A. When the set of returns includes only risk-free rates.
B. When the set of returns has a wide frequency distribution.
C. When the set of returns has a very narrow frequency distribution.
D. When all of the rates of return in the set of returns are equal to each other.
E. Never

Refer to section 10.5.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Arithmetic and geometric averages

35. Assume the securities markets are strong-form efficient. Given this assumption, you
should expect which one of the following to occur?
A. The risk premium on any security in that market will be zero.
B. The price of any one security in that market will remain constant at its current level.
C. Each security in the market will have an annual rate of return equal to the risk-free rate.
D. The price of each security in that market will frequently fluctuate.
E. The prices of each security will fall to zero because the net present value of the investments
will be zero.

Refer to section 10.6.

Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Strong-form efficient

10-18
Chapter 10 - Some Lessons from Capital Market History

36. New Labs just announced that it has received a patent for a product that will eliminate all
flu viruses. This news is totally unexpected and viewed as a major medical advancement.
Which one of the following reactions to this announcement indicates the market for New Labs
stock is efficient?
A. The price of New Labs stock remains unchanged.
B. The price of New Labs stock increases rapidly and then settles back to its pre-
announcement level.
C. The price of New Labs stock increases rapidly to a higher price and then remains at that
price.
D. All stocks quickly increase in value and then all but New Labs stock fall back to their
original values.
E. The value of all stocks suddenly increase and then level off at their higher values.

Refer to section 10.6.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Market efficiency

37. If the financial markets are efficient then:


A. stock prices should remain constant.
B. stock prices should increase or decrease slowly as new events are analyzed and the
information is absorbed by the markets.
C. an increase in the value of one security should be offset by a decrease in the value of
another security.
D. stock prices will only change when an event actually occurs, not at the time the event is
anticipated.
E. stock prices should only respond to unexpected news and events.

Refer to section 10.6.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Market efficiency

10-19
Chapter 10 - Some Lessons from Capital Market History

38. According to the Efficient Market Hypothesis, professional investors will earn:
A. excess profits over the long-term.
B. excess profits, but only on short-term investments.
C. a dollar return equal to the value paid for an investment.
D. a return that cannot be accurately predicted because investments are subject to the random
movements of the markets.
E. a return that "beats the market".

Refer to section 10.6.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Efficient Market Hypothesis

39. Semi-strong form market efficiency states that the value of a security is based on:
A. all public and private information.
B. historical information only.
C. all publicly available information.
D. all publicly available information plus any data that can be gathered from insider trading.
E. random information with no clear distinction as to the source of that information.

Refer to section 10.6.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Market efficiency

10-20
Chapter 10 - Some Lessons from Capital Market History

40. Dan is a chemist for ABC, a major drug manufacturer. Dan cannot earn excess profits on
ABC stock based on the knowledge he has related to his experiments if the financial markets
are:
A. weak form efficient.
B. strong form efficient.
C. semistrong form efficient.
D. efficient at any level.
E. aware that the trader is an insider.

Refer to section 10.6.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Market efficiency

41. If the financial markets are semi-strong form efficient, then:


A. only the most talented analysts can determine the true value of a security.
B. only individuals with private information have a marketplace advantage.
C. technical analysis provides the best tool to use to gain a marketplace advantage.
D. no one individual has an advantage in the marketplace.
E. every security offers the same rate of return.

Refer to section 10.6.

Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Market efficiency

10-21
Chapter 10 - Some Lessons from Capital Market History

42. One year ago, you purchased 400 shares of stock for $12 a share. The stock pays $0.22 a
share in dividends each year. Today, you sold your shares for $28.30 a share. What is your
total dollar return on this investment?
A. $6,222
B. $6,432
C. $6,520
D. $6,220
E. $6,608

Total dollar return = 400 ($28.30 - $12 + $0.22) = $6,608

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Total dollar return

43. One year ago, you purchased a 6 percent coupon bond with a face value of $1,000 when it
was selling for 101.2 percent of par. Today, you sold this bond for 99.8 percent of par. What is
your total dollar return on this investment?
A. $46
B. $60
C. $67
D. $74
E. $82

Total dollar return = (0.998 $1,000) - (1.012 $1,000) + (0.06 $1,000) = $46

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Total dollar return

10-22
Chapter 10 - Some Lessons from Capital Market History

44. Jones Footwear pays a constant annual dividend. Last year, the dividend yield was 2.8
percent when the stock was selling for $26 a share. What is the current price of the stock if the
current dividend yield is 3.1 percent?
A. $21.19
B. $23.48
C. $25.20
D. $26.87
E. $27.40

D = 0.028 $26 = $0.728


P0 = $0.728/0.031 = $23.48

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Dividend yield

45. The Triangle Store pays a constant dividend. Last year, the dividend yield was 5.4 percent
when the stock was selling for $18 a share. What must the stock price be today if the market
currently requires a 3.8 percent dividend yield on this stock?
A. $25.58
B. $14.76
C. $13.89
D. $23.16
E. $27.09

D = 0.054 $18 = $0.972


P0 = $0.972/0.038 = $25.58

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Dividend yield

10-23
Chapter 10 - Some Lessons from Capital Market History

46. The stock of Turner United is priced at $46 a share and has a dividend yield of 2.1
percent. The firm pays constant annual dividends. What is the amount of the next dividend per
share?
A. $0.021
B. $0.210
C. $0.966
D. $0.096
E. $0.219

D = 0.021 $46 = $0.966

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Dividend yield

47. One year ago, you bought a stock for $36.48 a share. You received a dividend of $1.62 per
share last month and sold the stock today for $40.18 a share. What is the capital gains yield on
this investment?
A. 2.86 percent
B. 3.70 percent
C. 10.14 percent
D. 12.29 percent
E. 14.58 percent

Capital gains yield = ($40.18- $36.48)/$36.48 = 10.14 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Capital gains yield

10-24
Chapter 10 - Some Lessons from Capital Market History

48. Aztec Movers pays a constant annual dividend of $1.55 per share on its stock. Last year at
this time, the market rate of return on this stock was 14.8 percent. Today, the market rate has
fallen to 11.2 percent. What would your capital gains yield have been if you had purchased
this stock one year ago and then sold the stock today?
A. 18.78 percent
B. 22.03 percent
C. 28.16 percent
D. 30.00 percent
E. 32.14 percent

P-1 = $1.55/0.148 = $10.47297


P0 = $1.55/0.112 = $13.83929
Capital gains yield = ($13.83929- $10.47297)/$10.47297 = 32.14 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Capital gains yield

49. One year ago, Steven purchased 4,200 shares of KNF stock for $177,072. Today, he sold
those shares for $48.10 a share. What is the capital gains yield on this investment if the
dividend yield is 3.3 percent?
A. 10.79 percent
B. 11.23 percent
C. 12.29 percent
D. 14.09 percent
E. 14.53 percent

Purchase price = $177,072/4,200 shares = $42.16 a share


Capital gains yield = ($48.10- $42.16)/$42.16 = 14.09 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Capital gains yield

10-25
Chapter 10 - Some Lessons from Capital Market History

50. One year ago, Neal purchased 3,600 shares of Franklin stock for $101,124. Today, he sold
those shares for $26.60 a share. What is the total return on this investment if the dividend
yield is 1.7 percent?
A. -4.21 percent
B. -3.60 percent
C. -2.29 percent
D. 1.10 percent
E. 2.42 percent

Purchase price = $101,124/3,600 shares = $28.09 a share


Total return = [($26.60 - $28.09)/$28.09] + 0.017 = -3.60 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Total return

51. One year ago, Theresa purchased 600 shares of Outland Co. stock for $3,600. The stock
does not pay any regular dividends but it did pay a special dividend of $0.25 a share last
week. This morning, she sold her shares for $7.25 a share. What was the total return on this
investment?
A. 18.00 percent
B. 20.83 percent
C. 22.50 percent
D. 25.00 percent
E. 27.33 percent

Purchase price = $3,600/600 shares = $6 a share


Total return = ($7.25 - $6 + $0.25)/$6 = 25 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Total return

10-26
Chapter 10 - Some Lessons from Capital Market History

52. Last year, Rita earned 11.6 percent on her investments while U.S. Treasury bills yielded
3.8 percent and the inflation rate was 3.1 percent. What real rate of return did she earn on her
investments last year?
A. 7.51 percent
B. 8.24 percent
C. 8.56 percent
D. 9.24 percent
E. 10.39 percent

Real return = (1.116/1.031) -1 = 8.24 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Real rate of return

53. You earned 26.3 percent on your investments for a time period when the risk-free rate was
3.8 percent and the inflation rate was 3.1 percent. What was your real rate of return for the
period?
A. 19.92 percent
B. 20.06 percent
C. 22.50 percent
D. 21.67 percent
E. 21.08 percent

Real return = (1.263/1.031) - 1 = 22.50 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Real rate of return

10-27
Chapter 10 - Some Lessons from Capital Market History

54. Katie earned a 2.7 percent real rate of return on her investments for the past year. During
that time, the risk-free rate was 4.1 percent and the inflation rate was 3.6 percent. What was
her nominal rate of return?
A. 5.30 percent
B. 5.87 percent
C. 6.40 percent
D. 6.67 percent
E. 6.91 percent

Nominal rate = (1.027 1.036) - 1 = 6.40 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Nominal rate of return

55. Hilltop Garage pays a constant annual dividend. One year ago, when you purchased shares
of that stock at $12 a share, the dividend yield was 2 percent. Over this past year, the inflation
rate has been 2.6 percent. Today, the required return on this stock is 8 percent and you just
sold all of your shares. What is your total nominal return on this investment?
A. -77 percent
B. -75 percent
C. -73 percent
D. -70 percent
E. -66 percent

Dividend = 0.02 $12 = $0.24


P0 = $0.24/0.08 = $3
Nominal return = ($3 - $12 + $0.24)/$12 = -73 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Nominal return

10-28
Chapter 10 - Some Lessons from Capital Market History

56. Last year, Thomas invested $38,000 in Oil Town stock, $11,000 in long-term government
bonds, and $8,000 in U.S. Treasury bills. Over the course of the year, he earned returns of
12.1 percent, 6.3 percent, and 3.9 percent, respectively. What was the nominal risk premium
on Oil Town's stock for the year?
A. 1.9 percent
B. 4.7 percent
C. 5.8 percent
D. 7.6 percent
E. 8.2 percent

Nominal risk premium = 12.1 percent - 3.9 percent = 8.2 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Risk premium

57. You expect the inflation rate to be 2.9 percent and the U.S. Treasury bill yield to be 3.7
percent for the next year. The risk premium on small-company stocks is 12.6 percent. What
nominal rate of return do you expect to earn on small-company stocks next year?
A. 15.5 percent
B. 16.3 percent
C. 16.8 percent
D. 9.2 percent
E. 9.7 percent

Nominal return on small-company stocks = 3.7 percent + 12.6 percent = 16.30 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Risk premium

10-29
Chapter 10 - Some Lessons from Capital Market History

58. Assume large-company stocks returned 11.8 percent on average over the past 75 years.
The risk premium on these stocks was 7.9 percent and the inflation rate was 3.2 percent. What
was the average nominal risk-free rate of return for those 75 years?
A. 3.90 percent
B. 9.27 percent
C. 4.26 percent
D. 8.33 percent
E. 8.60 percent

Nominal risk-free rate = 11.8 percent - 7.9 percent = 3.9 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Risk-free rate

59. Over the past five years, a stock returned 8.3 percent, -32.5 percent, -2.2 percent, 46.9
percent and 11.8 percent. What is the variance of these returns?
A. 0.071188
B. 0.076290
C. 0.081504
D. 0.082547
E. 0.091306

Average return = (0.083 -0.325 - 0.022 + 0.469 + 0.118)/5 = .0646


2 = [(0.083 - 0.0646)2 + (-0.325 - .0646)2 + (-0.022 - 0.0646)2 + (0.469 - 0.0646)2 + (0.118 -
0.0646)2]/(5 - 1) = 0.081504

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Variance

10-30
Chapter 10 - Some Lessons from Capital Market History

60. Windsor stock has produced returns of 22.6 percent, 18.7 percent, 11.3 percent, -19.8
percent, and 2.4 percent over the past five years, respectively. What is the variance of these
returns?
A. 0.028453
B. 0.031947
C. 0.035682
D. 0.039515
E. 0.040016

Average return = (0.226 + 0.187 + 0.113 - 0.198 + 0.024)/5 = 0.0704


2 = [(0.226 - 0.0704)2 + (0.187 - 0.0704)2 + (0.113 - 0.0704)2 + (-0.198 - 0.0704)2 + (0.024 -
0.0704)2]/(5 - 1) = 0.028453

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Variance

61. Five years ago, you purchased 600 shares of stock. The annual returns have been 7.2
percent, -19.4 percent, 3.8 percent, 14.2 percent, and 27.9 percent, respectively. What is the
variance of these returns?
A. 0.029889
B. 0.030021
C. 0.030068
D. 0.030133
E. 0.030284

Average return = (0.072 - 0.194 + 0.038 + 0.142 + 0.279)/5 = 0.0674


2 = [(0.072 - 0.0674)2 + (-0.194 - 0.0674)2 + (0.038 - 0.0674)2 + (0.142 - 0.0674)2 + (0.279 -
0.0674)2]/(5 - 1) = 0.029889

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Variance

10-31
Chapter 10 - Some Lessons from Capital Market History

62. Over the past six years, a stock had annual returns of 14 percent, -3 percent, 8 percent, 21
percent, -16 percent, and 4 percent, respectively. What is the standard deviation of these
returns?
A. 11.27 percent
B. 13.05 percent
C. 13.59 percent
D. 15.08 percent
E. 14.40 percent

Average return = (0.14 - 0.03 + 0.08 + 0.21 - 0.16 + 0.04)/6 = 0.046667


2 = [(0.14 - 0.046667)2 + (-0.03 - 0.046667)2 + (0.08 - 0.046667)2 + (0.21 - 00.046667)2 + (-
0.16 - 0.046667)2 + (0.04 - 0.046667)2]/(6 - 1) = 0.017027
= 0.017027 = 13.05 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Standard deviation

63. A stock has produced returns of 11 percent, 18 percent, -6 percent, -13 percent, and 21
percent for the past five years, respectively. What is the standard deviation of these returns?
A. 7.75 percent
B. 8.87 percent
C. 9.23 percent
D. 14.99 percent
E. 16.64 percent

Average return = (0.11 + 0.18 - 0.06 - 0.13 + 0.21)/5 = 0.062


2 = [(0.11 - 0.062)2 + (0.18 - 0.062)2 + (-0.06 - 0.062)2 + (-0.13 - 00.062)2 + (0.21 - 0.062)2 ]/
(5 - 1) = 0.02247
= 0.02247 = 14.99 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Standard deviation

10-32
Chapter 10 - Some Lessons from Capital Market History

64. A stock has yielded returns of 6 percent, 11 percent, 14 percent, and -2 percent over the
past 4 years, respectively. What is the standard deviation of these returns?
A. 5.52 percent
B. 5.86 percent
C. 6.05 percent
D. 6.47 percent
E. 6.99 percent

Average return = (0.06 + 0.11 + 0.14 - 0.02)/4 = 0.0725


2 = [(0.06 - 0.0725)2 + (0.11 - 0.0725)2 + (0.14 - 0.0725)2 + (-0.02 - 00.0725)2 ]/(4 - 1) =
0.004892
= 0.004892 = 6.99 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Standard deviation

65. Kelly decided to accept the risk and purchased a high growth stock. Her returns for the
past five years are 48 percent, 39 percent, -56 percent, 61 percent, and -24 percent. What is
the standard deviation of these returns?
A. 43.20 percent
B. 45.46 percent
C. 47.88 percent
D. 50.83 percent
E. 58.39 percent

Average return = (0.48 + 0.39 - 0.56 + 0.61 - 0.24)/5 = 0.136


2 = [(0.48 - 0.136)2 + (0.39 - 0.136)2 + (-0.56 - 0.136)2 + (0.61 - 00.136)2 + (-0.24 - 0.136)2 ]/
(5 - 1) = 0.258330
= 0.258330 = 50.83 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Standard deviation

10-33
Chapter 10 - Some Lessons from Capital Market History

66. Over the past 4 years, large-company stocks and U.S. Treasury bills have produced the
returns stated below. During this period, inflation averaged 2.8 percent. Given this
information, the average real rate of return on large-company stocks was ___ percent as
compared to _____ percent for Treasury bills.

A. 6.47; 0.92
B. 6.47; 1.08
C. 7.98; 0.92
D. 7.98; 1.08
E. 7.98; 1.22

Large-company stocks:
Average nominal return = (0.15 + 0.07 + 0.04 + 0.18)/4 = 0.11
Average real rate: r = (1.11/1.028) - 1 = 7.98 percent
U.S. Treasury bills:
Average nominal return = (0.06 + 0.03 + 0.02 + 0.04)/4 = 0.0375
Average real rate: r = (1.0375/1.028) - 1 = 0.92 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.3
Topic: Average real rate

10-34
Chapter 10 - Some Lessons from Capital Market History

67. Over the past 4 years, a stock produced returns of 15 percent, 6 percent, 11 percent, and
22 percent. Based on these 4 years, what range of returns would you expect to see 95 percent
of the time?
A. -6.58 percent to 31.33 percent
B. -6.58 percent to 27.02 percent
C. -6.58 percent to 24.39 percent
D. -0.02 percent to 24.39 percent
E. -0.02 percent to 27.02 percent

Average return = (0.15 + 0.06 + 0.11 + 0.22)/4 = 0.135


2 = [(0.15 - 0.135)2 + (0.06 - 0.135)2 + (0.11 - 0.135)2 + (0.22 - 00.135)2]/(4 - 1) = 0.004567
= 0.004567 = 0.067577 95 percent probability range = .0.135 (2 0.067577); -0.02
percent to 27.02 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Probability range

68. Over the past 4 years, a stock produced returns of 23 percent, -39 percent, 4 percent, and
16 percent. Based on these 4 years, what range of returns would you expect to see 99 percent
of the time?
A. -82.39 percent to 84.39 percent
B. -82.39 percent to 86.41 percent
C. -82.39 percent to 88.56 percent
D. -78.46 percent to 86.41 percent
E. -78.46 percent to 84.39 percent

Average return = (0.23 - 0.39 + 0.04 + 0.16)/4 = 0.01


2 = [(0.23 - 0.01)2 + (-0.3 - 0.01)2 + (0.04 - 0.01)2 + (0.16 - 0.01)2]/(4 - 1) = 0.077267
= 0.077267 = 0.277969 99 percent probability range = 0.01 (3 0.277969); -82.39
percent to 84.39 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Probability range

10-35
Chapter 10 - Some Lessons from Capital Market History

69. A security produced returns of 13 percent, 18 percent, 9 percent, 23 percent, and -17
percent over the past five years, respectively. Based on these five years, what is the
probability that this stock will earn more than 24.76 percent in any one given year?
A. 0.5 percent
B. 1.0 percent
C. 2.5 percent
D. 5.0 percent
E. 16.0 percent

Average return = (0.13 + 0.18 + 0.09 + 0.23 - 0.17)/5 = 0.092


2 = [(0.13 - 0.092)2 + (0.18 - 0.092)2 + (0.09 - 0.092)2 + (0.23 - 00.092)2 + (-0.17 - 00.092)2]/
(5 - 1) = 0.024220
= 0.024220 = 0.155628
Upper end of 68 percent probability range = 0.092 + 0.155628 = 24.76 percent Probability of
earning more than 24.76 percent = (1 - 0.68)/2 = 16 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Probability range

10-36
Chapter 10 - Some Lessons from Capital Market History

70. A security produced returns of 12 percent, -11 percent, -2 percent, 15 percent, and 9
percent over the past five years, respectively. Based on these five years, what is the
probability that an investor in this stock will lose more than 17.06 percent in any one given
year?
A. 0.50 percent
B. 1.00 percent
C. 1.25 percent
D. 2.50 percent
E. 5.00 percent

Average return = (0.12 - 0.11 - 0.02 + 0.15 + 0.09)/5 = 0.046


2 = [(0.12 - 0.046)2 + (-0.11 - 0.046)2 + (-0.02 - 0.046)2 + (0.15 - 0.046)2 + (0.09 - 0.046)2]/(5
- 1) = 0.01173
= 0.01173 = 0.108305
Lower end of 95 percent probability range = 0.046 - (2 0.108305) = -17.06 percent
Probability of losing more than 17.06 percent = (1 - 0.95)/2 = 2.5 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Probability range

71. A bond has an average return of 6.3 percent and a standard deviation of 3.8 percent. What
range of returns would you expect to see 68 percent of the time on this security?
A. -1.30 percent to 13.9 percent
B. -1.30 percent to 10.1 percent
C. 2.5 percent to 7.8 percent
D. 2.5 percent to 10.1 percent
E. 2.5 percent t0 13.9 percent

68 percent probability range = 0.063 0.038 = 2.5 percent to 10.1 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Probability range

10-37
Chapter 10 - Some Lessons from Capital Market History

72. A stock has an average return of 18.2 percent and a standard deviation of 10.7 percent. In
any one given year, you have a 95 percent chance that you will not lose more than _____
percent nor earn more than ____ percent if you invest in this security.
A. -3.2 percent to 28.9 percent
B. -3.2 percent to 39.6 percent
C. -13.9 percent to 28.9 percent
D. -13.9 percent to 39.6 percent
E. -13.9 percent to 50.3 percent

95 percent probability range = 0.182 (2 0.107) = -3.2 percent to 39.6 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Probability range

73. Home Grown Grains stock returned 28.7 percent, 2.6 percent, 13.1 percent, and 11.8
percent over the past four years, respectively. What is the arithmetic average return for this
period?
A. 14.05 percent
B. 14.62 percent
C. 15.10 percent
D. 15.93 percent
E. 16.01 percent

Arithmetic average = (0.287 + 0.026 + 0.131 + 0.118)/4 = 14.05 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Arithmetic average

10-38
Chapter 10 - Some Lessons from Capital Market History

74. You purchased 1,300 shares of LKL stock 5 years ago and have earned annual returns of
7.1 percent, 11.2 percent, 3.6 percent, -4.7 percent and 11.8 percent. What is your arithmetic
average return?
A. 4.47 percent
B. 5.80 percent
C. 6.23 percent
D. 6.47 percent
E. 6.98 percent

Arithmetic average = (0.071 + 0.112 + 0.036 - 0.047 + 0.118)/5 = 5.80 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Arithmetic average

75. A stock produced returns of 16 percent, 9 percent, and 21 percent over three of the past
four years. The arithmetic average for the past four years is 10 percent. What is the standard
deviation of the stock's returns for the 4-year period?
A. 6.82 percent
B. 8.54 percent
C. 9.09 percent
D. 10.83 percent
E. 11.75 percent

Average return = 0.10 = (0.16 + 0.09 + 0.21 + x)/4; x = -0.06


2 = [(0.16 - 0.10)2 + (0.09 - 0.10)2 + (0.21 - 0.10)2 + (-0.06 - 0.10)2]/(4 - 1) = 0.0138
= 0.0138 = 11.75 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Standard deviation

10-39
Chapter 10 - Some Lessons from Capital Market History

76. A stock produced returns of 19 percent, 27 percent, and -38 percent over three of the past
four years. The arithmetic average for the past four years is 7 percent. What is the standard
deviation of the stock's returns for the 4-year period?
A. 11.63 percent
B. 15.94 percent
C. 19.70 percent
D. 26.25 percent
E. 30.21 percent

Average return = 0.07 = (0.19 + 0.27 - 0.38 + x)/4; x = 0.20


2 = [(0.19 - 0.07)2 + (0.27 - 0.07)2 + (-0.38 - 0.07)2 + (0.20 - 0.07)2]/(4 - 1) = 0.091267
= 0.091267 = 30.21 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Standard deviation

77. Your portfolio has provided you with returns of 8.6 percent, 14.2 percent, -3.7 percent,
and 11.4 percent over the past four years, respectively. What is the geometric average return
for this period?
A. 7.25 percent
B. 7.40 percent
C. 7.57 percent
D. 7.63 percent
E. 7.78 percent

Geometric average return = (1.086 1.142 0.963 1.114)1/4 - 1 = 7.40 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Geometric return

10-40
Chapter 10 - Some Lessons from Capital Market History

78. The common stock of Western Hill Farms has yielded 16.3 percent, 7.2 percent, 11.8
percent, -3.6 percent, and 9.9 percent over the past five years, respectively. What is the
geometric average return?
A. 7.91 percent
B. 8.03 percent
C. 8.11 percent
D. 8.27 percent
E. 8.32 percent

Geometric average return = (1.163 1.072 1.118 0.964 1.099)1/5 - 1 = 8.11 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Geometric return

79. A stock has produced returns of 15.6 percent, 3.4 percent, 11.7 percent, and -9.2 percent
over the past four years, respectively. What is the geometric average return?
A. 4.93 percent
B. 5.47 percent
C. 6.23 percent
D. 6.61 percent
E. 7.08 percent

Geometric average return = (1.156 1.034 1.117 0.908)1/4 - 1 = 4.93 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Geometric return

10-41
Chapter 10 - Some Lessons from Capital Market History

80. Over the last four years, the common stock of Plymouth Shippers has had an arithmetic
average return of 9.3 percent. Three of those four years produced returns of 14.1 percent, 15.6
percent, and 3.4 percent. What is the geometric average return for this 4-year period?
A. 7.72 percent
B. 8.41 percent
C. 8.93 percent
D. 9.16 percent
E. 9.368 percent

Arithmetic average return = 0.093 = (0.141 + 0.156 + 0.034 + x)/4; x = 0.041


Geometric average return = [1.141 1.156 1.034 1.041)1/4 - 1 = 9.16 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Arithmetic and geometric returns

81. Over the last four years, a stock has had an arithmetic average return of 8.8 percent. Three
of those four years produced returns of 16.3 percent, 10.2 percent, and -14.1 percent. What is
the geometric average return for this 4-year period?
A. 7.83 percent
B. 8.39 percent
C. 8.67 percent
D. 9.40 percent
E. 9.97 percent

Arithmetic average return = 0.088 = (0.163 + 0.102 - 0.141 + x)/4; x = 22.8 percent
Geometric average return = [1.163 1.102 0.859 1.228)1/4 - 1 = 7.83 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Arithmetic and geometric returns

10-42
Chapter 10 - Some Lessons from Capital Market History
Essay Questions

82. Explain why investors receive exactly what they pay for in a totally efficient market.

In a totally efficient market, the NPV of an investment is equal to zero, which means the
market value of the investment is exactly equal to the investment's cost.

Feedback: Refer to section 10.6.

AACSB: Reflective thinking


Bloom's: Comprehension
Difficulty: Intermediate
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Efficient market

83. There are regulations that prohibit "insider trading", which is the use of non-public
information about a security to earn abnormal profits from trading that security. Which form
of market efficiency would make these laws unnecessary? Explain why.

If the markets were strong-form efficient, all inside information would be included in the
market prices. Thus, insider information would have no added value.

Feedback: Refer to section 10.6.

AACSB: Reflective thinking


Bloom's: Application
Difficulty: Intermediate
Learning Objective: 10-04 Assess the implications of market efficiency
Section: 10.6
Topic: Insider trading

10-43
Chapter 10 - Some Lessons from Capital Market History

84. For the period 1926-2008, small-company stocks had a risk premium of 12.6 percent.
What does the term "risk premium" mean? Is the risk premium on these stocks considered to
be relatively high or relative low as compared to other investment classes? Explain why.

Risk premium is the excess return required from an investment in a risky asset over that
required from a risk-free investment. Small-company stocks have a relatively high risk
premium due to the more volatile nature of their returns.

Feedback: Refer to section 10.4.

AACSB: Reflective thinking


Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Total return

85. Over the period of 1926-2008, U. S. Treasury bills had an average return of 3.8 percent
while inflation averaged 3.1 percent. Based on this historical record, is it safe to assume that
an investor in U.S. Treasury bills will enjoy a positive real rate of return each year? Why or
why not?

No. While U.S. Treasury bills had positive real returns for the period 1926-2008, they will not
necessarily do so annually due to the volatility of both the T-bill returns and the rate of
inflation. A review of either Figure 10.4 or Table 10.1 illustrates this.

Feedback: Refer to section 10.2.

AACSB: Reflective thinking


Bloom's: Comprehension
Difficulty: Basic
Learning Objective: 10-02 Discuss the historical returns on various important types of investments
Section: 10.2
Topic: Real returns

10-44
Chapter 10 - Some Lessons from Capital Market History
Multiple Choice Questions

86. Suppose a stock had an initial price of $74 per share, paid a dividend of $0.80 per share
during the year, and had an ending share price of $76. What was the capital gains yield?
A. 2.70 percent
B. 3.29 percent
C. 3.78 percent
D. 4.01 percent
E. 4.23 percent

Capital gains yield = ($76 - $74)/$74 = 2.70 percent


EOC #: 10.1

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Capital gains yield

87. Suppose you bought a 6 percent coupon bond one year ago for $929. The bond sells today
for $933. The face value is $1,000. If the inflation rate last year was 3.4 percent, what was
your total real rate of return on this investment?
A. 3.37 percent
B. 3.92 percent
C. 4.31 percent
D. 6.89 percent
E. 7.08 percent

Nominal return = ($933 - $929 + $60)/$929 = 0.068891


Real rate = (1.068891/1.034) - 1 = 3.37 percent
EOC #: 10.4

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.3
Topic: Real returns

10-45
Chapter 10 - Some Lessons from Capital Market History

88. A stock has returns for five years of 23 percent, -17 percent, 8 percent, 22 percent, and 3
percent. The stock has an average return of ______ percent and a standard deviation of _____
percent.
A. 7.80; 13.54
B. 7.80; 14.63
C. 7.80; 16.36
D. 14.60; 14.63
E. 14.60; 16.36

Average return = (0.23 - 0.17 + 0.08 + 0.22 + 0.03)/5 = 0.078


2 = [(0.23 - 0.078)2 + (-0.17 - 0.078)2 + (0.08 - 0.078)2 + (0.22 - 00.078)2 + (0.03 - 00.078)2]/
(5 - 1) = 0.026770
= 0.026770 = 16.36 percent
EOC #: 10.7

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.4
Topic: Standard deviation

89. You've observed the following returns on Blast It Corporation's stock over the past five
years: 11 percent, -28 percent, 16 percent, 18 percent, and - 3 percent. What was the variance
of the returns over this period?
A. .03598
B. .03637
C. .03692
D. .03714
E. .03781

Average return = (0.11 - 0.28 + 0.16 + 0.18 - 0.03)/5 = 0.028


2 = [(0.11 - 0.028)2 + (-0.28 - 0.028)2 + (0.16 - 0.028)2 + (0.18 - 00.028)2 + (-0.03 - 00.028)2]/
(5 - 1) = 0.03637
EOC #: 10.9

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.4
Topic: Variance

10-46
Chapter 10 - Some Lessons from Capital Market History

90. You purchased a zero-coupon bond one year ago for $291.22. The market interest rate is
now 8.75 percent. If the bond had 16 years to maturity when you originally purchased it, what
was your total return for the past year if the face value of the bond is $1,000?
A. -4.97 percent
B. -2.18 percent
C. 1.34 percent
D. 2.65 percent
E. 2.90 percent

PV = $1,000/[1 + (0.0875/2)]30 = $276.76


Total return = ($276.76 - $291.22)/$291.22 = -4.97 percent
EOC #: 10.13

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Total return

91. You bought a share of 6.5 percent preferred stock for $87.40 last year. The market price
for your stock is now $88.10. What is your total return for last year?
A. 7.51 percent
B. 7.73 percent
C. 7.86 percent
D. 8.19 percent
E. 8.24 percent

Total return = ($88.10 - $87.40 + $6.50)/$87.40 = 8.24 percent


EOC #: 10.14

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.1
Topic: Total return

10-47
Chapter 10 - Some Lessons from Capital Market History

92. Assume that long-term corporate bonds had an average return of 6.3 percent and a
standard deviation of 8.3 percent for a 30-year period. What range of returns would you
expect to see on these bonds 68 percent of the time?
A. -2.0 percent to 14.6 percent
B. -2.0 percent to 22.9 percent
C. -10.3 percent to 14.6 percent
D. -10.3 percent to 17.4 percent
E. -10.3 percent to 22.9 percent

68 percent range = 6.3 percent 8.3 percent = -2.0 percent to 14.6 percent
EOC #: 10.17

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Return distributions

93. Assume that large-company stocks had an average return of 11.8 percent and a standard
deviation of 20.7 percent for a 40-year period. What range of returns would you expect to see
on these stocks 95 percent of the time?
A. -50.3 percent to 53.2 percent
B. -50.3 percent to 73.9 percent
C. -50.3 percent to 64.1 percent
D. -29.6 percent to 73.9 percent
E. -29.6 percent to 53.2 percent

95 percent range = 11.8 percent (2 20.7 percent) = -29.6 percent to 53.2 percent
EOC #: 10.18

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 10-03 Explain the historical risks on various important types of investments
Section: 10.4
Topic: Return distributions

10-48
Chapter 10 - Some Lessons from Capital Market History

94. You find a certain stock that had returns of 14 percent, -27 percent, 19 percent, and 21
percent for four of the last five years. The average return of the stock over this period was 9.5
percent. What is the standard deviation of the stock's returns?
A. 11.67 percent
B. 12.90 percent
C. 14.14 percent
D. 18.47 percent
E. 20.59 percent

Average return = 0.095 = (0.14 - 0.27 + 0.19 + 0.21 + x)/5; x = .205


2 = [(0.14 - 0.095)2 + (-0.27 - 0.095)2 + (0.19 - 0.095)2 + (0.21 - 00.095)2 + (0.205 -
00.095)2]/(5 - 1) = 0.0424
= 0.0424 = 20.59 percent
EOC #: 10.19

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.4
Topic: Average return and standard deviation

95. A stock has had returns of 11 percent, -8 percent, 6 percent, 21 percent, 24 percent, and 16
percent over the last six years. What is the geometric return for this stock?
A. 10.82 percent
B. 11.13 percent
C. 11.31 percent
D. 11.42 percent
E. 11.47 percent

Geometric average = (1.11 0.92 1.06 1.21 1.24 1.16)1/6 -1 = 11.13 percent
EOC #: 10.20

AACSB: Analytic
Bloom's: Analysis
Difficulty: Intermediate
Learning Objective: 10-01 Calculate the return on an investment
Section: 10.5
Topic: Geometric return

10-49