Chapter 10 : Some Lessons from Capital Market History
Chapter 10 : Some Lessons from Capital Market History FIN 323
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This 3 page Class Notes was uploaded by Leosinh on Saturday March 19, 2016. The Class Notes belongs to FIN 323 at Marshall University taught by Dr. Shaorong Zhang in Spring 2016. Since its upload, it has received 16 views. For similar materials see Principles of Finance in Business at Marshall University.
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Date Created: 03/19/16
Chapter 10 : Some Lessons from Capital Market History Important More Important Most important Dollar Returns : If you buy an asset of any sort, your gain (or loss ) from that investment is called your return on investment. There are two components : 1) You may receive some cash directly while you own the investment. This is called the income component of your return. 2) The value of the asset you purchase will often change. In this case, you have a capital gain or capital loss on your investment. The total dollar return on your investment is the sum of the dividend and the capital gain : Total dollar return = Dividend income + Capital gain ( or loss). Total cash if stock is sold = Initial Investment + Total Return The Historical record : 1) Large-company stocks. The large-company stock portfolio is based on the Standard & Poor’s 500 index , which contains 500 of the largest companies ( in terms of total market value of outstanding stock) in the United States. 2) Small-company stocks. This is a portfolio composed of stock of smaller companies, where “small” corresponds to the smallest 20 percent of the companies listed on the New York Stock Exchange, again as measured by market value of outstanding stock. 3) Long-term corporate bonds. This is a portfolio of high-quality bonds within 20 years to maturity. 4) Long-term U.S government bonds. This is a portfolio of U.S government bonds with 20 years to maturity. 5) U.S Treasury bills. This is based on Treasury bills ( T-bills for short ) with a one-month maturity. Average Returns : The first lesson. Calculating Average Returns : the obvious way to calculate the average returns on the different investments in Table 10.1 is simply to add up the yearly return and divide by 86. Risk Premiums : The difference between these two returns can be interpreted as a measure of the excess return on the average risky asset ( assuming the stock of a large U.S corporation has about average risk compared to all risky assets. The variability of returns : The second lesson. Frequency Distributions and Variability. Variance : the average squared difference between the actual return and the average return. Standard deviation : the positive square root of the variance. Normal distribution (or bell-curve) : a symmetric, bell-shaped frequency distribution that is completely defined by its average and standard deviation. More on average returns: Arithmetic versus Geometric Averages: The 0 percent is called the geometric average return. The 25 percent is called the arithmetic average return. The geometric average return answers: “ What was your average compound return per year over a particular period ?”. Calculating Geometric Average Returns: Capital market efficiency: Efficient capital market : market in which security prices reflect available information. Efficient markets hypothesis (EMH) : the hypothesis that actual capital markets, such as the NYSE , are efficient.
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