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73 Cards in this Set
- Front
- Back
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list investments from lowest historical risk to highest risk |
1) US Treasury bills 2) Long-term corporate bonds 3) Large company stocks 4) small company stocks |
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2008 Iceland Exchange shares dropped what percent in one day? |
76% |
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Studying market history can reward us by demonstrating that... |
The greater the potential reward is, the greater the risk. There is a reward for bearing risk |
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the square of the standard deviation is equal to the ... |
variance |
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The second lesson from studying capital market history states that the _________ the potential reward, the _________ the risk |
greater, greater less, less |
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An efficient market is one that reflects all available... |
information |
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In an efficient market __________ investments have a __________ NPV |
all, zero |
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What are some important characteristics of the normal distribution? |
It is bell shaped and symmetrical |
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small company stocks had the highest risk level t-bills which had the lowest risk, generated the lowest return small company stocks generated the highest average return |
This describes the data over the long-term Ibbotoson data |
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What are ways to make money by investing in stocks? |
capital gains dividends |
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When a company declares a dividend, shareholders generally receive _______ |
cash |
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What is a promissory note? |
A form of debt |
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The two ways of calculating average returns are ________ and _________ |
The geometric average the arithmetic average |
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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 one year, what is the stock's current dividend yield? |
2% Div yield = Div / orig. price |
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What is the geometric average return formula? |
{[(1+R1) * (1+R2) ... (1+Rx)] ^ 1/t} -1 |
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The capital gain yield can be found by finding the difference between the ending stock price and the initial stock price and diving it by the what? |
initial stock price |
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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 what percent? |
.5% 3.5% - 3% = .5% |
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Using capital market history as a guide, it would appear the greatest reward would come from investing in _________ |
small company common stock |
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percentage returns are more convenient than dollar returns because they |
apply to any amount invested allow comparison against other investments |
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common stocks frequently experience positive or negative returns? |
negative |
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T-bills sometimes, always or never outperform common stocks? |
sometimes |
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The excess return is the difference btwn the rate of return on a risky asset and the _________ rate |
risk free |
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The efficient markets hypothesis contends that ________ capital markets such as the NYSE are effecient |
well organized |
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The Ibbotoson-sinquefield data shows that... |
US T-bills had the lowest risk or variability long-term corporate bonds had less risk or variability than stocks |
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If a series of stock returns has a variance of .0068, what is the standard deviation? |
8.246% take the sq. rt of .0068 |
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If the arithmetic average return is 10% and the variance of returns is .05, find the approx geometric mean |
7.5% |
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The dividend yield for a one-year period is equal to the annual dividend amount divided by the __________ |
beginning stock price |
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The total dollar return on a stock is the ________ and the _________ |
dividends capital gains |
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What were a bright spot for US investors during 2008? |
bonds |
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What is the equation for the capital asset pricing model? |
Expected return on security = risk free rate + Beta * (return on market - risk free rate) |
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What are examples of a portfolio? |
investing in 50 publicly traded corporations investing in a combination of US and Asian stocks investing in a combination of stocks and bonds |
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The appropriate discount rate to use to evaluate a new projects is the _____________ |
cost of capital |
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Standard deviation is the square root of what? |
variance |
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Variance is a measure of the squared deviations of what? |
A security's return from its expected return |
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How do you find the expected rate of return on an asset with a boom probability of .25 and an E(r) of 10%. A normal prob of .50 and E(r) of 4% and a bust prob of .25 and E(r) of -6%...? |
(.25)*(10%) + (.50)*(4%) + (.25)*(-6%) = 3% |
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The systematic risk principle argues that the market does not reward risks that are (2 things).. |
borne unnecessarily diversifiable |
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What are the 4 steps of computing variance? |
1) calculate the expected return 2) calculate the deviation of each return from the expected return 3) square each deviation 4) calculate the average squared deviation |
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John's portfolio consists of $1200 worth of Chi Coprortation common stock and $400 worth of Lambda Corp common stock. Lambda's portfolio weight is 25%, and Chi's portfolio weight is: |
75% |
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What types of risks are reduced by diversification? |
Asset-specific risk unsystematic risk unique risk |
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What does unsystematic risk affect? |
A specific firm firms in a single industry |
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_________ risk is the only risk important to the well diversified investor. |
systematic |
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As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk? |
it may eventually be almost totally eliminated it is likely to decrease |
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What does the risk of owning an asset come from? |
surprises unanticipated events |
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By definition, what is the beta of the average asset equal to? |
1 |
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A security has a beta of 1, a market risk premium of 8% and a risk-free rate of 3%. What will happen to the expected return if the beta doubles? |
The expected return will increase to 19% from 11% 3% +1 * 8% = 11% 3% + 2*8% = 19%, which is less than double |
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What are the two components of risky return (U) in the total return equation? |
market risk unsystematic risk |
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What is a risk premium ? |
it is additional compensation for taking risk, over and above the risk free rate |
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What is the expected return for a security if the risk-free rate is 5%, the expected return on the market is 9%, and the security's beta is 1.5? |
11% 5+ 1.5*(9-5) =11% |
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What is the reward to risk ratio? |
[E (Ra) - Rt] / Ba |
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what is an example of unsystematic risk? |
Changes in management labor strikes an increase in competition in the industry |
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What is the intercept of the security market line (SML)? |
the risk free rate |
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What are examples of systematic risk? |
regulatory changes in tax rates future rates of inflation |
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If security ABC has a beta of 1.5 and security XYZ has a beta of 1, what is the best beta of a portfolio that is equally invested in both securities? |
1.25 portfolio beta = .5 * 1.5 + .5 * 1 |
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What two factors determine a stock's total return? |
expected return unexpected return |
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What is a systematic risk? |
it is risk that pertains to a large number of assets |
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To determine the appropriate required return for an investment, we can use _____________ |
The security market line (sml) |
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The calculation of a portfolio beta is similar to the calculation of what? |
a portfolio's expected return |
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boom prob: .25 boom port. return: 10% normal prob: .5 normal port return: 4% bust prob: .25 bust portfolio return: -6% what is the standard deviation of the portfolio? |
5.74% mean return = .5*.04+.258-.06= .25*.1 = .03 stdev = [.25(.1-.03)^2 +.5(.04-.03)^2 +.25(.06-.03)^2]^.5 = .0574 |
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Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio.... |
declines |
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What is the slope of the security market line (SML)? |
market risk premium |
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What will happen over time if a firm uses its overall WACC to evaluate all projects, regardless of each project's risk level? |
It will reject projects it should have accepted and visa versa the firm overall will become riskier |
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In many cases, the dividend growth model approach is ___________? |
useless |
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What does WACC stand for? |
Weighted average cost of capital |
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To apply the dividend discount model to a particular stock, you need to estimate the... |
growth rate dividend yield |
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What is the equation for finding the cost of preferred stock? |
Rp = D/ Po |
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It;s yields can be calculated from observable data, and it is easier to estimate than the cost of equity. What is this describing? |
Cost of debt |
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What is the formula for SML? |
Re = Rf + Beta* (Rm - Rf) |
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What components are used in the construction of the WACC? |
Cost of debt cost of common stock cost of preferred stock |
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If an all- equity firm discounts a project's cash flows with the firm's overall weighted average cost of capital even though the project's beta is less than the firm's overall beta, it is possible that the project might be... |
rejected when it should be accepted because if the overall cost of capital is used, the project's cash flows will be discounted too severely, leading to possible rejected of the value creating project |
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Suppose a firm's capital structure consists of 30% debt, 10% preferred stock and 60% equity. The firm's bonds yield 10% on average before taxes, the cost of preferred stock is 8% and the cost of equity is 16%. Calculate the firm's WACC assuming a tax rate of 40% |
12.20% |
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If a forecast for a firm's earnings growth is 7% and its dividend yield is 3%, it's cost of equity will be... |
10% 3% + 7% = 10 |
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According to the CAPM, what is the expected return on stock of it's beta is equal to zero? |
the risk free rate |
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The cost of capital depends on the ________ of funds not the ________ |
use source |
