CHAPTER 12
Some Lessons from Capital Market History
I. DEFINITIONS
RISK PREMIUM
a 1. The excess return required from a risky asset over that required from a risk-free asset
is called the:
a. risk premium. b. geometric premium. c. excess return. d. average return. e. variance.
VARIANCE
b 2. The average squared difference between the actual return and the average return is
called the:
a. volatility return. b. variance. c. standard deviation. d. risk premium. e. excess return.
STANDARD DEVIATION
c 3. The standard deviation for a set of stock returns can be calculated as the: a. positive square root of the average return. b. average squared difference between the actual return and the average return. c. positive square root of the variance. d. average return divided by N minus one, where N is the number of returns. e. variance squared.
NORMAL DISTRIBUTION
d 4. A symmetric, bell-shaped frequency distribution that is completely defined by its mean
and standard deviation is the _____ distribution.
a. gamma b. Poisson c. bi-modal d. normal e. uniform
GEOMETRIC AVERAGE RETURN
d 5. The average compound return earned per year over a multi-year period is called the
_____ average return.
a. arithmetic b. standard c. variant d. geometric e. real
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ARITHMETIC AVERAGE RETURN
a 6. The return earned in an average year over a multi-year period is called the _____
average return.
a. arithmetic b. standard c. variant d. geometric e. real
EFFICIENT CAPITAL MARKET
e 7. An efficient capital market is one in which: a. brokerage commissions are zero. b. taxes are irrelevant. c. securities always offer a positive rate of return to investors. d. security prices are guaranteed by the U.S. Securities and Exchange Commission to be
fair.
e. security prices reflect available information.
EFFICIENT MARKETS HYPOTHESIS
a 8. The notion that actual capital markets, such as the NYSE, are fairly priced is called the: a. Efficient Markets Hypothesis (EMH). b. Law of One Price. c. Open Markets Theorem. d. Laissez-Faire Axiom. e. Monopoly Pricing Theorem.
STRONG FORM EFFICIENCY
b 9. The hypothesis that market prices reflect all available information of every kind is
called _____ form efficiency.
a. open b. strong c. semi-strong d. weak e. stable
SEMI STRONG FORM EFFICIENCY
c 10. The hypothesis that market prices reflect all publicly-available information is called
_____ form efficiency.
a. open b. strong c. semi-strong d. weak e. stable
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WEAK FORM EFFICIENCY
d 11. The hypothesis that market prices reflect all historical information is called _____
form efficiency.
a. open b. strong c. semi-strong d. weak e. stable
II. CONCEPTS
TOTAL RETURN
d 12. The total percentage return on an equity investment is computed using the formula
______, where P1 is the purchase cost, P2 represents the sale proceeds, and d is the dividend income.
a. (P2 – P1) ? (P2 + d) b. (P1 – P2) ? (P2 + d) c. (P1 – P2 – d) ? P1 d. (P2 – P1 + d) ? P1 e. (P2 – P1 + d) ? P2
DIVIDEND YIELD
a 13. The dividend yield is equal to _____, where P1 is the purchase cost, P2 represents the
sale proceeds, and d is the dividend income.
a. d ? P1 b. d ? P1 c. d ? P2 d. d ? P2 e. d ? (P1 + P2)
DIVIDEND YIELD
c 14. The Zolo Co. just declared that they are increasing their annual dividend from $1.00
per share to $1.25 per share. If the stock price remains constant, then:
a. the capital gains yield will decrease. b. the capital gains yield will increase. c. the dividend yield will increase. d. the dividend yield will also remain constant. e. neither the capital gains yield nor the dividend yield will change.
CAPITAL GAIN
b 15. The dollar amount of the capital gain on an investment is computed as _____, where P1
is the purchase cost, P2 represents the sale proceeds, and d is the dividend income.
a. P1 – P2 b. P2 – P1 c. P2 ? P1 d. P1 – P2 + d e. P2 – P1 – d
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TOTAL RETURN
e 16. The capital gains yield plus the dividend yield on a security is called the: a. variance of returns. b. geometric return. c. average period return. d. summation of returns. e. total return.
REAL RETURN
c 17. The real rate of return on a stock is approximately equal to the nominal rate of return: a. multiplied by (1 + inflation rate). b. plus the inflation rate. c. minus the inflation rate. d. divided by (1 + inflation rate). e. divided by (1- inflation rate).
REAL RETURN
c 18. As long as the inflation rate is positive, the real rate of return on a security investment will be ____ the nominal rate of return. a. greater than b. equal to c. less than d. greater than or equal to e. unrelated to
HISTORICAL RECORD
d 19. A portfolio of large company stocks would contain which one of the following types of
securities?
a. stock of the firms which represent the smallest 20 percent of the companies listed on
the NYSE
b. U.S. Treasury bills c. long-term corporate bonds d. stocks of firms included in the S&P 500 index e. long-term government bonds
HISTORICAL RECORD
d 20. Based on the period of 1926 through 2003, _____ have tended to outperform other
securities over the long-term.
a. U.S. Treasury bills b. large company stocks c. long-term corporate bonds d. small company stocks e. long-term government bonds
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HISTORICAL RECORD
a 21. Which one of the following types of securities has tended to produce the lowest real
rate of return for the period 1926 through 2003?
a. U.S. Treasury bills b. long-term government bonds c. small company stocks d. large company stocks e. long-term corporate bonds
HISTORICAL RECORD
d 22. On average, for the period 1926 through 2003: a. the real rate of return on U.S. Treasury bills has been negative. b. small company stocks have underperformed large company stocks. c. long-term government bonds have produced higher returns than long-term corporate
bonds.
d. the risk premium on long-term corporate bonds has exceeded the risk premium on
long-term government bonds.
e. the risk premium on large company stocks has exceeded the risk premium on small
company stocks.
HISTORICAL RECORD
e 23. Over the period of 1926 through 2003, the annual rate of return on _____ has been
more volatile than the annual rate of return on_____:
a. large company stocks; small company stocks. b. long-term government bonds; long-term corporate bonds. c. U.S. Treasury bills; long-term government bonds. d. long-term corporate bonds; small company stocks. e. large company stocks; long-term corporate bonds.
HISTORICAL RECORD
d 24. During the period of 1926 through 2003 the annual rate of inflation: a. was always positive. b. was only negative during the 3 years of the Great Depression. c. never exceeded 10 percent. d. fluctuated significantly from one year to the next. e. tended to be negative during the years of World War II.
HISTORICAL RECORD
e 25. Based on the period of 1926 through 2003 the annual rate of inflation ranged from
_____ percent to _____ percent.
a. -5; 6 b. -5; 9 c. -7; 6 d. -7; 15 e. -10; 18