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Chapter 12 Some Lessons from Capital Market History 1. Investors shouldn't count capital gains as part of total returns until the security is sold, since the capital gain is really only a "paper gain" up to that point. Ans: False

Level: Basic

Subject: Total Returns

Type: Concepts

2. The total return on a security is made up of two components: the capital gains component and the price appreciation component. Ans: False

Level: Basic

Subject: Total Returns

Type: Concepts

3. In general, the longer the term of an investment the lower the risk premium will be. Ans: False

Level: Basic

Subject: Risk Premiums

Type: Concepts

4. On the basis of historical data from the 1948-2002 period, the return on the average Treasury bill has fluctuated more than the return on the average long bond. Ans: False

Level: Basic

Subject: Risk & Return

Type: Concepts

5. On the basis of historical data from the 1948-2002 period, the return on the average common stock has fluctuated less than the return on the average stock of small firms. Ans: True

Level: Basic

Subject: Risk & Return

Type: Concepts

6. A growth stock is a stock that results in a high return with relatively low levels of risk. Ans: False

Level: Basic

Subject: Growth Stocks

Type: Concepts

7. Generally speaking, financial markets are less efficient than real asset markets. Ans: False

Level: Basic

Subject: Efficient Markets

Type: Concepts

8. Your classmate just made $10,000 in a single day by trading in the stock market. It is reasonable to conclude, therefore, that the efficient market hypothesis cannot be true. Ans: False

Level: Basic

Subject: Efficient Markets

Type: Concepts

9. On most days, you notice that stock prices fluctuate wildly. It is obvious to you that markets are inefficient during this period. Ans: False

Level: Basic

Subject: Market Efficiency

Type: Concepts

10. Capital market efficiency is attributable largely to the lack of competition among market participants for information. Ans: False

Level: Basic

Subject: Efficient Markets

Type: Concepts

11. If insiders were allowed to profit on their inside information without penalty, financial markets would be less efficient. Ans: True

Level: Basic

Subject: Efficient Markets

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 1

Chapter 12 Some Lessons from Capital Market History

12. The excess return required on a risky asset over that earned on a risk-free asset is called a: A) Risk premium. B) Return premium. C) Excess return. D) Average return. E) Variance. Ans: A

Level: Basic

Subject: Risk Premiums

Type: Definitions

13. The average squared difference between the actual return and the average return is the: A) Average return. B) Variance. C) Standard deviation. D) Risk premium. E) Excess return. Ans: B

Level: Basic

Subject: Variance

Type: Definitions

14. The standard deviation for a set of stock returns can be calculated as: A) The positive square root of the average return. B) The average squared difference between the actual return and the average return. C) The positive square root of the variance. D) The average return divided by N minus one, where N is the number of returns. E) The variance squared. Ans: C

Level: Basic

Subject: Standard Deviation

Type: Definitions

15. A symmetric, bell-shaped statistical 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 Ans: D

Level: Basic

Subject: Normal Distribution

Type: Definitions

16. 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 Ontario Securities Commission) to be fair. E) Security prices reflect available information. Ans: E

Level: Basic

Subject: Efficient Capital Markets

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 2

Chapter 12 Some Lessons from Capital Market History

17. The notion that actual capital markets, such as the TSX, 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. Ans: A

Level: Basic

Subject: Efficient Markets Hypothesis

Type: Definitions

18. The hypothesis that market prices reflect all available information is called efficiency in the: A) Open form. B) Strong form. C) Semi-strong form. D) Weak form. E) Stable form. Ans: B

Level: Basic

Subject: Strong Form Efficiency

Type: Definitions

19. The hypothesis that market prices reflect all publicly-available information is called efficiency in the: A) Open form. B) Strong form. C) Semi-strong form. D) Weak form. E) Stable form. Ans: C

Level: Basic

Subject: Semi-Strong Form Efficiency

Type: Definitions

20. The hypothesis that market prices reflect all historical information is called efficiency in the: A) Open form. B) Strong form. C) Semi-strong form. D) Weak form. E) Stable form. Ans: D

Level: Basic

Subject: Weak Form Efficiency

Type: Definitions

21. Risk premium is defined as: A) The total return on a risky asset that exceeds the inflation rate. B) The return on a risky asset that exceeds the return on a risk-free asset. C) The risk-free rate of return plus the inflation rate. D) The real rate of return that exceeds the risk-free rate of return. E) The rate of return required by investors in risky assets. Ans: B

Level: Basic

Subject: Risk Premium

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 3

Chapter 12 Some Lessons from Capital Market History

22. (Dt+1 / Pt) + [(Pt+1 – Pt)/ Pt] is the mathematical expression for the: A) Dividend yield. B) Capital gains yield. C) Total risk premium. D) Total rate of return. E) Real rate of return. Ans: D

Level: Basic

Subject: Total Return

Type: Definitions

23. The dollar rate of return on an investment can be mathematically defined as: A) (Dt+1 + Pt+1 - Pt) / Pt. B) (Dt + Pt+1 - Pt) / Pt. C) (Dt+1 / Pt) + (Pt+1 - Pt / Pt). D) Dt + Pt+1 - Pt. E) Dt+1 + Pt+1 - Pt. Ans: E

Level: Basic

Subject: Dollar Rate Of Return

Type: Definitions

24. The 95% probability range is defined as the: A) Risk premium plus or minus two times the standard deviation. B) Risk premium plus or minus two times the variance. C) Mean plus or minus two times the standard deviation. D) Mean plus or minus three times the standard deviation. E) Mean plus or minus three times the variance. Ans: C

Level: Basic

Subject: Probability Range

Type: Definitions

25. The square of the standard deviation is called the: A) Risk premium. B) Average rate of return. C) Excess return. D) Variance. E) Probability range. Ans: D

Level: Basic

Subject: Variance

Type: Definitions

26. The three probability ranges used with a normal distribution are defined as the _____ ranges. A) 75%, 85%, and 95% B) 68%, 75%, and 99% C) 68%, 85%, and 99% D) 68%, 85%, and 95% E) 68%, 95%, and 99% Ans: E

Level: Basic

Subject: Probability Ranges

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 4

Chapter 12 Some Lessons from Capital Market History

27. For a stock that does not pay a dividend, the total return can also be defined as the: A) Risk premium plus the inflation rate. B) Capital gains rate. C) Real rate of return. D) Financial rate of return. E) Nominal after-tax rate of return. Ans: B

Level: Basic

Subject: Capital Gains Rate

Type: Definitions

28. A normal distribution is a statistical distribution that is defined by its: A) Probability ranges. B) Historical rates of return. C) Average rate of return and variance. D) Mean and standard deviation. E) Mean and capital gain ranges. Ans: D

Level: Basic

Subject: Normal Distribution

Type: Definitions

29. If a company insider uses all of her knowledge about the company stock and still has no advantage in the marketplace over outside investors, the market has to be: A) Semi-strong form efficient. B) Strong form efficient. C) Weak form efficient. D) Overpriced. E) Underpriced. Ans: B

Level: Basic

Subject: Strong Form Efficient

Type: Definitions

30. An efficient market is defined as one where all investments in that market are____ investments. A) Zero net present value B) Positive net present value C) Zero real rate of return D) Zero risk premium E) Positive real rate of return Ans: A

Level: Basic

Subject: Strong Form Efficient

Type: Definitions

31. An asset's return on investment has two components, one of which is ____________, which reflects the cash you receive directly while you own the investment. A) the capital gain B) the income component C) your reward for bearing risk D) your total dollar return E) your gross return on that investment Ans: B

Level: Basic

Subject: Income Component Of Return

Copyright © 2005 McGraw-Hill Ryerson Limited.

Type: Concepts

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Chapter 12 Some Lessons from Capital Market History

32. Which of the following correctly completes this sentence: When calculating your return on investment you should ignore _____________. A) paper gains which you could have obtained by cashing out B) losses you avoided by not buying a stock that has since decreased in price C) dividends that have been declared on the stock you own if you have not yet received the dividend D) paper capital losses that occur E) fees you are charged in the process of purchasing the asset in question Ans: B

Level: Basic

Subject: Components of Return

Type: Concepts

33. Last year you purchased 100 shares of Marvel Entertainment stock for $12 per share. According to today's quote in The National Post, the stock is currently selling for $18 per share. The stock pays no dividends. Your return on this investment is comprised of _____________________. A) an income return only B) an income return and a capital gains return C) a real return only D) a capital gains return only E) a dividend yield only Ans: D

Level: Basic

Subject: Capital Gains Return

Type: Concepts

34. Based on the historical record from 1948 to 2002, which of the following types of Canadian securities earned the SECOND highest return? A) Long bonds B) Small stocks C) Inflation D) Canadian Treasury bills E) Common stocks (S&P /TSX Composite) Ans: E

Level: Basic

Subject: Historical Returns

Type: Concepts

35. Which of the following investments have grown faster than the rate of inflation over the period 1948-2002? I. Canadian common stocks II. Treasury bills III. Long bonds IV. Small stocks A) I and III only B) I, II, and IV C) III and IV only D) I and II only E) I, II, III, and IV Ans: E

Level: Basic

Subject: Historical Returns

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

36. Over the past 50 years, which of the following Canadian investments has provided the largest average return? A) Canadian common stocks B) Inflation C) Treasury bills D) Long bonds E) Canadian small stocks Ans: E

Level: Basic

Subject: Historical Returns

Type: Concepts

37. Over the past 50 years, which of the following investments has provided the smallest average return? A) Canadian common stocks B) U.S. common stocks C) Treasury bills D) Long bonds E) Canadian small stocks Ans: C

Level: Basic

Subject: Historical Returns

Type: Concepts

38. Over the past 50 years, which of the following investments has been considered the most risky? A) Canadian common stocks B) U.S. common stocks C) Treasury bills D) Long bonds E) Canadian small stocks Ans: E

Level: Basic

Subject: Historical Risk

Type: Concepts

39. Over the past 50 years, which of the following investments has been the least risky? A) Canadian common stocks B) U.S. common stocks C) Treasury bills D) Long bonds E) Canadian small stocks Ans: C

Level: Basic

Subject: Historical Risk

Type: Concepts

40. Which of the following statements about historical security returns is/are true? I. Stocks of small companies have higher average returns than those of larger companies. II. Risky securities have higher average returns than riskless securities. III. Long bonds have higher average yields than Treasury bills. IV. Historical information about capital markets is useful for drawing conclusions about the relationship between risk and return. A) I and III only B) I, II, and III only C) III and IV only D) I and II only E) I, II, III, and IV Ans: E

Level: Basic

Subject: Historical Returns

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

41. Why do long-term government bonds have a risk premium? A) They are not default-free. B) They are virtually identical to long-term corporate bonds. C) The government cannot easily raise tax money to repay the bonds. D) The long time period to maturity. E) Long-term government bonds don't have a risk premium. Ans: D

Level: Basic

Subject: Long-Term Government Bonds

Type: Concepts

42. Which of the following is true about risk and return? A) Riskier assets will, on average, earn lower returns. B) The reward for bearing risk is known as the standard deviation. C) Based on historical data, there is no reward for bearing risk. D) An increase in the risk of an investment will result in a decreased risk premium. E) In general, the higher the risk the higher the expected return. Ans: E

Level: Basic

Subject: Risk & Return

Type: Concepts

43. Which of the following is true? A) Risky assets on average do not earn a risk premium. B) There is a reward for bearing risk, on average. C) On average, the greater the risk, the lower the reward. D) When comparing the common stock of two firms, the riskier one will have the lower price. E) If a market is not efficient, then all assets in that market will have the same reward to risk ratio. Ans: B

Level: Basic

Subject: Risk Premiums

Type: Concepts

44. Which of the following is likely to be associated with the highest level of risk? A) Long-term corporate bonds B) Canadian Treasury bills C) Long-term government bonds D) Common stock of the largest companies in Canada E) Common stock of the smallest companies listed on the TSX Ans: E

Level: Basic

Subject: Investment Risk

Type: Concepts

45. Which of the following is generally considered to represent the risk-free return? A) Common stocks B) Treasury bills C) Small stocks D) Long bonds E) Inflation Ans: B

Level: Basic

Subject: Risk-Free Return

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

46. Over the 1957-2002 period, the risk premium on long bonds has averaged ________ per year. A) 0.0% B) 1.6% C) 2.1% D) 9.4% E) 13.6% Ans: C

Level: Basic

Subject: Risk Premiums

Type: Concepts

47. Over the 1957-2002 period, the risk premium on small stocks has averaged ________ per year. A) 0.0% B) 1.95% C) 2.35% D) 6.42% E) 13.65% Ans: D

Level: Basic

Subject: Risk Premiums

Type: Concepts

48. Over the 1957-2002 period, the risk premium on Canadian common stocks has averaged ______ per year. A) 0.0% B) 1.96% C) 2.36% D) 3.40% E) 13.66% Ans: D

Level: Basic

Subject: Risk Premiums

Type: Concepts

49. You are considering two investments. You note that the return on investment A tends to vary quite widely from its average, definitely more so than does investment B. Based on this, you believe that: A) A has a lower variance than B. B) A has a lower standard deviation than B. C) A has a higher inflation premium than B. D) A has a higher return volatility than B. E) A must be stock in one of the largest Canadian firms while B must be stock in one of the smallest firms listed on the TSX Ans: D

Level: Basic

Subject: Variance

Type: Concepts

50. _________________ is one of the most commonly used measures of return volatility. A) The normal distribution B) The inflation rate C) The risk premium D) Standard deviation E) Return on investment Ans: D

Level: Basic

Subject: Volatility

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 9

Chapter 12 Some Lessons from Capital Market History

51. Over the 1957-2002 period, the standard deviation of returns for Canadian common stocks has averaged _________ per year. A) 3.22% B) 8.62% C) 9.22% D) 16.41% E) 33.28% Ans: D

Level: Basic

Subject: Historical Volatility

Type: Concepts

52. Over the 1957-2002 period, the standard deviation of returns for small stocks has averaged ______________ per year. A) 3.28% B) 8.68% C) 9.28% D) 20.38% E) 23.05% Ans: E

Level: Basic

Subject: Historical Volatility

Type: Concepts

53. Over the 1957-2002 period, the standard deviation of returns for long bonds has averaged ___________ per year. A) 3.27% B) 8.67% C) 10.47% D) 20.37% E) 33.87% Ans: C

Level: Basic

Subject: Historical Volatility

Type: Concepts

54. The normal distribution is useful in analyzing security returns because: A) We frequently deal with finite data sets. B) Of its bell-shaped appearance. C) 95% of all observations fall within two standard deviations of the mean. D) The distribution of security returns is usually different from a normal distribution. E) It can be completely described by its mean and standard deviation. Ans: E

Level: Basic

Subject: Normal Distribution

Type: Concepts

55. The lessons from capital market history tell us: I. There is a reward for bearing risk. II. The greater the potential reward from a risky asset, the greater is the risk. III. The TSX is an inefficient market. A) I only B) II only C) I and II only D) I and III only E) I, II, and III Ans: C

Level: Basic

Subject: Capital Market History

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 10

Chapter 12 Some Lessons from Capital Market History

56. If capital markets are efficient, then ________________________. A) there is no reason to believe that prices are too high or too low B) it is possible to profit regularly from publicly available information C) prices will adjust slowly when reacting to new information D) it is not possible to make money by playing the stock market E) historical price trends will give you a good idea of where prices are headed in the future Ans: A

Level: Basic

Subject: Efficient Markets

Type: Concepts

57. Which of the following is NOT correct with regards to the Efficient Markets Hypothesis? A) The EMH suggests that there are no positive NPV investments, on average. B) The EMH asserts that information has been "priced out" of stocks. C) The EMH refers to well-organized capital markets. D) The EMH suggests that the prices on the TSX are fair, on average. E) The EMH suggests that markets in which prices fluctuate a great deal cannot be efficient. Ans: E

Level: Basic

Subject: Efficient Markets

Type: Concepts

58. Which form(s) of market efficiency is/are generally considered to hold in well-organized markets? I. Strong form efficiency II. Semi-strong form efficiency III. Weak form efficiency A) I only B) II only C) III only D) I and II only E) II and III only Ans: E

Level: Basic

Subject: Efficient Markets

Type: Concepts

59. Which of the following is implied by the evidence regarding market efficiency? A) Prices in well-organized capital markets are unfair. B) There is a simple way to identify mispriced stocks when they exist. C) Prices don't respond rapidly to new information. D) It is difficult to predict future price movements based on public information. E) Insiders cannot make money from their private information. Ans: D

Level: Basic

Subject: Efficient Markets

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

60. Assume that markets are semi-strong form efficient. Suppose, then, that during a trading day, important new information is released for the first time concerning a certain company. This information indicates that one of the firm's oil fields, previously thought to be very promising, just came up dry. How would you expect the price of a share of stock to react to this information? A) The value of a share will fall over an extended period of time as investors begin to sell shares in the company. B) The value of a share will drop immediately to a price that reflects the value of the new information. C) The value of a share will fall below what is considered appropriate because of the decreased demand for the shares, but eventually the price will rise to the correct level. D) The value of a share will rise over a long period of time as investors sell the stock. E) The stock price will not change since this type of information has no impact in markets that are semistrong form efficient. Ans: B

Level: Basic

Subject: Efficient Markets

Type: Concepts

61. IBM announces that earnings per share for the current quarter are $1.25; this figure is barely half of what investors and analysts expected. In an efficient market, the price of IBM stock will A) change immediately to reflect changes in investor expectations B) gradually fall over several days as investors assimilate the new information C) first fall, reflecting investors' surprise; then rise back somewhat as investors assimilate the new information D) probably not change at all E) fall only if there is additional unfavourable news about IBM announced at the same time Ans: A

Level: Basic

Subject: Efficient Markets

Type: Concepts

62. Suppose you purchase a stock expecting the price to rise in the coming year. After one year, your stock has actually decreased in value, due primarily to adverse information released during the year. Which of the following describes this result? A) This is not a violation of market efficiency. B) This is a violation of weak form efficiency. C) This is a violation of semi-strong form efficiency. D) This is a violation of strong form efficiency. E) This is a violation of all forms of market efficiency. Ans: A

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

63. You discover that you can make greater than expected returns by buying stock in firms whenever the growth rate in sales predicted by an investment survey exceeds the stock's current price-earnings ratio. Which of the following describes this event? A) This would not be a violation of market efficiency. B) This would be a violation of weak form efficiency. C) This would be a violation of semi-strong form efficiency but not of weak form efficiency. D) This would be a violation of strong form efficiency but not of semi-strong form efficiency. E) This would be a violation of all forms of market efficiency. Ans: C

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

64. You discover you can make above normal returns if you buy oil-company stocks just before noon on any given trading day and then sell them immediately before the market closes that same day. Which of the following describes this event? A) This would not be a violation of market efficiency. B) This would be a violation of weak form efficiency. C) This would be a violation of semi-strong form efficiency. D) This would be a violation of strong form efficiency. E) This would be a violation of all forms of market efficiency. Ans: B

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

65. An efficient market implies _________________________. A) that, on average, all investments have a negative NPV B) that, on average, all investments have a zero NPV C) that, on average, all investments have a positive NPV D) that there tend to be more positive NPV investments than negative NPV investments E) Nothing about the NPV of an investment Ans: B

Level: Basic

Subject: Efficient Markets

Type: Concepts

66. Which of the following statements about market efficiency is generally considered to be true? A) For inefficient markets, security prices will rapidly reflect new information. B) It is easy to forecast the direction of future security price changes in the short run. C) Short-run price changes occur independent of information coming to the market. D) On average, most stocks are mispriced. E) In the absence of legal constraints, investors with inside information will be able to earn excess returns. Ans: E

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

67. Which of the following is NOT correct about market efficiency? A) The EMH says that actual capital markets, such as the TSX, are efficient. B) Strong form efficiency says all information of any kind is reflected in stock prices. C) Semi-strong form efficiency says all public and private information is reflected in stock prices. D) Weak form efficiency says studying past prices in an attempt to identify mispriced stocks is futile. E) The price a firm obtains when it sells its stock in an efficient market is a fair price, in the sense that the price reflects available information about the stock. Ans: A

Level: Intermediate

Subject: Market Efficiency

Type: Concepts

68. You have discovered from looking at charts of past stock prices that if you buy just after a stock price has declined for three consecutive days, you make money every time! This is a violation of ________ market efficiency. A) weak form B) semi-weak form C) semi-strong form D) strong form E) TSX stock Ans: A

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

69. In efficient markets, investments have which of the following attributes? I. Expected return equal to zero II. Expected NPV equal to zero III. Expected risk premium equal to zero A) I only B) II only C) I and II only D) I and III only E) II and III only Ans: B

Level: Basic

Subject: Efficient Markets

Type: Concepts

70. Driving in your car, you hear that Microsoft has announced that they have cornered the market on Internet technology. Knowing this is great news for Microsoft, when you arrive at a phone 30 minutes later you call your broker and are able to buy Microsoft stock before its price moves up on the news. This is a violation of ___________ market efficiency. A) weak form B) semi-weak form C) semi-strong form D) strong form E) TSX stock Ans: C

Level: Basic

Subject: Efficient Markets

Type: Concepts

71. While eating in an exclusive restaurant in New York City, you overhear two executives negotiating a merger. When you check the news about the two companies after lunch you find there is no public information about any merger. Thus, you buy shares of stock in both firms and make a killing when the merger is announced publicly two days later. This is a violation of ______________ market efficiency. A) weak form B) semi-weak form C) semi-strong form D) strong form E) TSX stock Ans: D

Level: Basic

Subject: Efficient Markets

Type: Concepts

72. The market return on the Canadian Treasury bill is generally used as the measure of the: A) Real rate of market return. B) Real rate of return on a risk-free investment. C) Nominal risk premium rate of return. D) Risk-free rate of return. E) Risk premium on government bonds. Ans: D

Level: Basic

Subject: Risk-Free Rate Of Return

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 14

Chapter 12 Some Lessons from Capital Market History

73. The nominal rate of return on large-company stocks consists of a: A) Risk-free rate of return plus an inflation adjustment. B) Real rate of return plus the Treasury bill rate of return. C) Risk premium plus the Treasury bill rate of return. D) Risk-free rate of return plus a bond premium. E) Real risk-free rate of return plus a risk premium. Ans: C

Level: Intermediate

Subject: Risk Premium

Type: Concepts

74. Which of the following are included in the market prices if the market is semi-strong efficient? I. All historical information II. All insider information III. All public information IV. All information of any kind A) I only B) III only C) I and III only D) I, II, and III only E) I, II, III, and IV Ans: C

Level: Intermediate

Subject: Semi-strong Efficiency

Type: Concepts

75. If the stock market is weak form efficient, then an investor can NOT earn excess profits by: A) Trading on insider information. B) Trading on newly released public information. C) Identifying mispriced securities. D) Studying historical price patterns. E) Studying financial statements as they become available. Ans: D

Level: Intermediate

Subject: Weak Form Efficiency

Type: Concepts

76. If a market is efficient, then the difference between the market value of an investment and its cost is: A) Zero. B) Positive and greater than 1. C) Equal to the risk premium. D) Equal to the net present value of the cash inflows. E) Equal to the risk-free rate of return. Ans: A

Level: Basic

Subject: Market Efficiency

Type: Concepts

77. Last year you purchased a stock at $21.63 a share. Today you sold your shares at $23.01 after receiving your quarterly dividend. The total return on this stock consists of: A) A capital gain only. B) A capital loss only. C) A capital gain and a dividend yield. D) A capital loss and a dividend yield. E) A dividend yield and a risk-free rate of return. Ans: C

Level: Intermediate

Subject: Total Return

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

78. Which one of the following has the highest risk premium based on historical information? A) Canadian Treasury bill B) Corporate bonds C) Large-company stocks D) Government bonds E) Small-company stocks Ans: E

Level: Intermediate

Subject: Risk Premium

Type: Concepts

79. Historical information has shown that there is ______ relationship between the rate of return and the risk of an investment. A) No B) An indirect C) A random D) A direct E) An inverse Ans: D

Level: Basic

Subject: Risk And Return

Type: Concepts

80. You are an investor who studies the price movements of stock to identify patterns that are repetitive. By doing this, you have been able to earn higher returns than normal. This would be a violation of: A) The risk-return tradeoff. B) The normal risk premium reward. C) Strong form efficiency. D) Semi-strong form efficiency. E) Weak form efficiency. Ans: E

Level: Intermediate

Subject: Weak Form Efficiency

Type: Concepts

81. The higher the standard deviation of a stock the: A) Greater the probability of losing more than 50% of your investment in any one year. B) Lower the risk premium given a normal market. C) Lower the volatility level over a period of time. D) Narrower the bell curve and the smaller the probability ranges. E) Greater the probability that the actual return for any one year will equal the average historical return. Ans: A

Level: Intermediate

Subject: Standard Deviation

Type: Concepts

82. Which one of the following types of investments would be associated with the narrowest bell curve? A) Large-company stocks B) Corporate bonds C) Long-term government bonds D) Small-company stocks E) Treasury bills Ans: E

Level: Basic

Subject: Bell Curve

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 16

Chapter 12 Some Lessons from Capital Market History

83. Which of the following statements concerning probability ranges of a normal distribution is (are) correct? I. The 99% probability range is equal to the mean plus or minus three times the variance. II. With a mean of 5% and a standard deviation of 10%, the probability of earning more than 25% in any one year is no more than 2.5%. III. If the lowest return for a 68% probability range is -21%, then there is a 32% chance that the loss in any one year will be greater than 21%. IV. The mean is equal to the average variance of an investment over a period of time. A) I only B) II only C) I and III only D) II and IV only E) II, III, and IV only Ans: B

Level: Intermediate

Subject: Probability Ranges

Type: Concepts

84. The variance is the: A) Average risk premium over a period of time. B) Average of the squared deviations from the mean. C) Total of the squared deviations from the average. D) Positive square root of the standard deviation. E) Average difference between the actual return and the average return. Ans: B

Level: Intermediate

Subject: Variance

Type: Concepts

85. Which one of the following categories has the lowest positive, non-zero, risk premium? A) Large-company stocks B) Long-term government bonds C) Small-company stocks D) Treasury bills E) Long-term corporate bonds Ans: B

Level: Basic

Subject: Risk Premium

Type: Concepts

86. Which one of the following statements is true concerning market performance over the period 1957-2002? A) Over the short-term, small-company stocks are less volatile than large-company stocks. B) Canadian Treasury bills tend to pay a higher rate of return than do long-term government bonds. C) Canadian Treasury bills have paid returns in excess of 10% in some years. D) Over the long-term, large-company stocks outperform small-company stocks. E) Canadian Treasury bills always have a positive real rate of return. Ans: C

Level: Intermediate

Subject: Historical Performance

Type: Concepts

87. The historical record demonstrates that the risk of loss decreases when the _____ increases. A) Time horizon B) Standard deviation C) Variance D) Volatility E) Average return Ans: A

Level: Intermediate

Subject: Holding Period

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

88. Which of the following statements is (are) true concerning risk and return? I. To accept higher levels of risk, investors must be paid a higher risk premium. II. Small-company stocks offer a higher return and less risk than large-company stocks. III. The risk-free rate of return is based on the long-term government bond rate. IV. The higher the standard deviation, the less predictable the rate of return in any one year. A) I only B) II only C) III and IV only D) I and II only E) I and IV only Ans: E

Level: Intermediate

Subject: Risk And Return

Type: Concepts

89. The frequency distribution of large-company stocks since 1948 shows that: A) These stocks have never lost more than 30% of their value in any one year. B) These stocks have never produced a rate of return higher than 40% in any one year. C) These stocks tend to have a normal distribution around a positive mean over the long-term. D) These stocks return negative rates of return about half of the time. E) There is minimal risk in these stocks over the short-term. Ans: C

Level: Intermediate

Subject: Frequency Distribution

Type: Concepts

90. The total of the deviations of actual returns from the average return will: A) Always be positive and greater than zero. B) Sometimes be positive and sometimes be negative. C) Always be equal to zero. D) Always be greater than the average return. E) Be greater the larger the degree of volatility. Ans: C

Level: Intermediate

Subject: Deviation

Type: Concepts

91. Which one of the following statements is correct concerning the historical standard deviations of asset classes over the period 1957-2002? A) The standard deviation of small-company stocks is almost three times the average annual return for those stocks. B) The standard deviation of large-company stocks demonstrates they have more risk than any other category. C) The historical standard deviation of long-term corporate bonds is less than the standard deviation of large-company stocks. D) Long-term corporate bonds are more volatile than Canadian Treasury bills as shown by their standard deviations. E) The historical standard deviation of large-company stocks is greater than the standard deviation of small-company stocks. Ans: D

Level: Intermediate

Subject: Standard Deviation

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

92. You purchased a bond on January 1, 2002 for $839.67. The bond has a $1,000 face value, an 8% annual coupon, and can be sold for $842.33 on December 31, 2002. What is your total dollar return for the year? A) $2.66 B) $10.66 C) $72.34 D) $77.34 E) $82.66 Ans: E

Level: Basic

Subject: Dollar Return

Type: Problems

93. You purchased 200 shares of preferred stock on January 1, 2002 for $42.27 per share. The stock pays an annual dividend of $7 per share. On December 31, 2002 the market price is $46.88 per share. What is your total dollar return for the year? A) $478 B) $922 C) $1,400 D) $2,322 E) $2,678 Ans: D

Level: Basic

Subject: Dollar Return

Type: Problems

94. You purchased a bond on January 1, 2002 for $839.67. The bond has a $1,000 face value, an 8% annual coupon, and can be sold for $822.33 on December 31, 2002. What is your percentage return on investment for the year? A) -2.1% B) 7.5% C) 8.6% D) 11.6% E) 11.8% Ans: B

Level: Basic

Subject: Percentage Return

Type: Problems

95. You purchased 200 shares of preferred stock on January 1, 2002 for $42.27 per share. The stock pays an annual dividend of $5 per share. On December 31, 2002 the market price is $43.88 per share. What is your percentage return on investment for the year? A) 4.9% B) 8.0% C) 14.9% D) 15.1% E) 15.6% Ans: E

Level: Basic

Subject: Percentage Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

96. You purchased a bond for $900 one year ago. Today, you receive your only interest payment for the year of $100. The bond can currently be sold for $975. What is your total percentage return on investment? Ignore tax effects. A) 8.3% B) 11.1% C) 18.0% D) 19.4% E) 23.8% Ans: D

Level: Basic

Subject: Investment Returns

Type: Problems

97. An investment earned the following returns for the years 2000 through 2003:-20%, 50%, 30%, and 10%. What is the variance of returns for this investment? A) 0.0892 B) 0.1121 C) 0.1541 D) 0.1747 E) 0.2987 Ans: A

Level: Basic

Subject: Variance

Type: Problems

98. Given the following historical returns, what is the variance? Year 1 = 8%; year 2 = -12%; year 3 = 6%; year 4 = 1%; year 5 = -19%. A) 0.0063 B) 0.0089 C) 0.0139 D) 0.0394 E) 0.1178 Ans: C

Level: Basic

Subject: Variance

Type: Problems

99. Given the following historical returns, what is the standard deviation? Year 1 = 20%; year 2 = -12%; year 3 = 16%; year 4 = 3%; year 5 = -15%. A) 11.89% B) 12.48% C) 14.18% D) 15.85% E) 16.87% Ans: D

Level: Basic

Subject: Standard Deviation

Type: Problems

100. Given the following returns, what is the variance? Year 1 = 15%; year 2 = 3%; year 3 = -29%; year 4 = -1%. A) 0.0137 B) 0.0182 C) 0.0347 D) 0.0398 E) 0.0468 Ans: C

Level: Basic

Subject: Variance

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 20

Chapter 12 Some Lessons from Capital Market History

101. Over the last three years you earned 5%, 7%, and 9%. What is the standard deviation of your returns? A) 0.8% B) 1.6% C) 2.0% D) 2.3% E) 2.9% Ans: C

Level: Basic

Subject: Standard Deviation

Type: Problems

102. Which of the following two stocks is more volatile based on their historical returns? Year 1 2 3 4 5 Return A .04 .06 .08 .10 .12 Return B .08 .09 .10 .11 .12 A) B) C) D) E)

A because it has a lower mean B because it has a higher mean A because it has a higher standard deviation B because it has a lower standard deviation B because it has a higher variance

Ans: C

Level: Basic

Subject: Historical Volatility

Type: Problems

103. If we assume that the annual return on common stocks are normally distributed, then approximately 95% of the returns will fall within the range ___________% if the average historical return is 13.2% with a standard deviation of 20.3%. A) 7.1 to 33.5 B) -7.1 to 33.5 C) -27.4 to 33.5 D) -5.1 to 45.7 E) -27.4 to 53.8 Ans: E

Level: Basic

Subject: Normal Distribution

Type: Problems

Use the following to answer questions 104-107: You purchase 100 shares of stock at a price of $45 per share. One year later, the shares are selling for $47 per share. In addition, a dividend of $4 per share is paid at the end of each year. 104. What is the total dollar return for the investment? A) $400 B) $500 C) $600 D) $800 E) $1,200 Ans: C

Level: Basic

Subject: Total Dollar Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

105. What is the capital gains yield for the investment? A) 4.4% B) 5.5% C) 8.5% D) 8.9% E) 13.3% Ans: A

Level: Basic

Subject: Capital Gains Yield

Type: Problems

106. What is the dividend yield for the investment? A) 4.4% B) 5.5% C) 8.5% D) 8.9% E) None of the above. Ans: D

Level: Basic

Subject: Dividend Yield

Type: Problems

107. What is the total percentage return for the investment? A) 5.5% B) 8.5% C) 8.9% D) 12.8% E) 13.3% Ans: E

Level: Basic

Subject: Percentage Return

Type: Problems

Use the following to answer questions 108-111: You purchased 500 shares of a stock at a price of $22.50 per share. One year later, the shares sold for $21 each. At that end of the year, a $1.50 per share dividend was paid. 108. What is the total dollar return for the investment? A) $0 B) $750 C) $1,250 D) $1,500 E) $1,750 Ans: A

Level: Basic

Subject: Total Dollar Return

Type: Problems

109. What is the capital gains yield for the investment? A) -7.1% B) -6.7% C) 0.0% D) 6.7% E) 7.1% Ans: B

Level: Basic

Subject: Capital Gains Yield

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 22

Chapter 12 Some Lessons from Capital Market History

110. What is the dividend yield for the investment? A) -7.1% B) -6.7% C) 0.0% D) 6.7% E) 7.1% Ans: D

Level: Basic

Subject: Dividend Yield

Type: Problems

111. What is the total percentage return for the investment? A) -7.1% B) -6.7% C) 0.0% D) 6.7% E) 7.1% Ans: C

Level: Basic

Subject: Percentage Return

Type: Problems

Use the following to answer questions 112-116: Use the following historical average returns and standard deviations to answer the question(s) below. Asset Average Return Standard Deviation Canadian common stocks 13.20% 16.62% US common stocks 15.59% 16.86% Long bonds 7.64% 10.57% Small-company stocks 14.79% 23.68% Treasury bills 6.04% 4.04%

112. What is the historical risk premium on Canadian common stocks? A) 0% B) 7.16% C) 9.55% D) 1.60% E) 8.75% Ans: B

Level: Basic

Subject: Risk Premiums

Type: Problems

113. What is the historical risk premium of Canadian common stocks over long bonds? A) 7.15% B) 7.16% C) 5.56% D) 1.60% E) 8.75% Ans: C

Level: Basic

Subject: Risk Premiums

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

114. Based on the historical data above, what is your reward for bearing risk of owning small-company stocks rather than Canadian common stocks? A) 1.59% B) 0.80% C) 2.39% D) 1.60% E) 4.25% Ans: A

Level: Basic

Subject: Risk Premiums

Type: Problems

115. If the returns on small-company stocks are normally distributed, which of the following returns would lie in a 99% confidence interval around the mean, but not in a 95% confidence interval? A) -30% B) -10% C) 50% D) 70% E) 90% Ans: D

Level: Intermediate

Subject: Normal Distribution

Type: Problems

116. Assume the return on T-bills is normally distributed. Assuming a 68% probability, what is the highest return you would expect to earn on T-bills? A) 2.00% B) 4.04% C) 6.04% D) 10.08% E) 14.12% Ans: D

Level: Intermediate

Subject: Normal Distribution

Type: Problems

117. Marti purchased a stock one year ago at a price of $23.89. Over the past year she has received a total of $1.63 in dividends. Today she sold the stock for $22.84. What percentage total return did Marti earn on this investment? A) 2.43% B) 2.54% C) 4.40% D) 6.82% E) 7.14% Ans: A

Level: Basic

Subject: Total Return

Type: Problems

118. Sam purchased a stock for $46.91 one year ago. Today he sold the stock for $48.03. The stock paid a total of $1.40 in dividends over the year. What capital gains yield did Sam realize on this investment? A) 2.33% B) 2.39% C) 2.67% D) 3.13% E) 5.37% Ans: B

Level: Basic

Subject: Capital Gains Yield

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 24

Chapter 12 Some Lessons from Capital Market History

119. Frederico paid $86.70 for a stock one year ago. Today he sold the stock for $88.20. Over the year, Frederico received four quarterly dividends of $0.60 each. What was the dividend yield on this investment? A) 0.69% B) 1.02% C) 2.77% D) 4.42% E) 4.50% Ans: C

Level: Basic

Subject: Dividend Yield

Type: Problems

120. A stock produced total returns of 10.4%, -11.9%, - 21.7%, and 31.2% over the past four years, respectively. What is the average rate of return for this period of time? A) 1.50% B) 1.67% C) 2.00% D) 2.34% E) 2.67% Ans: C

Level: Basic

Subject: Average Rate Of Return

Type: Problems

121. A stock produced total returns of 9.78%, 13.61%, 1.19%, and -4.90% over the past four years, respectively. What is the variance on this set of returns? A) 0.70% B) 0.88% C) 1.38% D) 1.63% E) 2.09% Ans: A

Level: Basic

Subject: Variance

Type: Problems

122. You purchased a five-year 6% annual coupon bond one year ago for $990. You sold the bond today when the market rate of return is 4.5%. If the inflation rate for the past year was 2.0%, what nominal rate of return did you earn on this investment? A) 7.07% B) 8.16% C) 10.30% D) 11.67% E) 12.51% Ans: E

Level: Intermediate

Subject: Nominal Rate Of Return

Type: Problems

123. Angelo purchased a 7% annual coupon bond one year ago for $987. At the time of purchase, the bond had six years to maturity. Over the past year inflation has been 3.2%. The market required return on this bond today is 8%. If Angelo sells the bond today at the market price, what real rate of return will he realize on this investment? A) -1.16% B) 1.13% C) 1.17% D) 4.33% E) 4.36% Ans: B

Level: Intermediate

Subject: Real Rate Of Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

124. A stock produced total returns of 11.5%, 8.3%, and -2.4% over the past three years, respectively. Based on this information what range of returns would you expect to see 95% of the time? A) -36.70% to 25.10% B) -26.40% to 14.80% C) -14.80% to 26.40% D) -25.10% to 36.70% E) -35.40% to 47.00% Ans: D

Level: Intermediate

Subject: Probability Distributions

Type: Problems

125. ABC stock pays a $1.80 annual dividend. The market price of the stock was $21.74, $19.83, $22.60, and $23.10 at the end of the past four years, respectively. Based on this information, what is the mean rate of return? A) 9.67% B) 10.91% C) 11.25% D) 19.14% E) 21.82% Ans: B

Level: Intermediate

Subject: Mean Rate Of Return

Type: Problems

126. A stock has an average rate of return of 11.5% and a standard deviation of 12.8%. What is the probability that the stock will lose more than 26.9% in any one year? A) 0.50% B) 1.00% C) 1.25% D) 2.50% E) 5.00% Ans: A

Level: Intermediate

Subject: Probability Distributions

Type: Problems

127. Over the past three years, a stock has produced capital gains of 3.6%, 42.9%, and -18.6%, respectively. The stock does not pay a dividend. Based on this information what is the approximate probability than the stock will double in value in any one year? A) 0.0% B) 0.5% C) 1.0% D) 2.5% E) 5.0% Ans: B

Level: Intermediate

Subject: Probabilty Distributions

Type: Problems

128. Assume that for some period of time corporate bonds had an average rate of return of 5.4% while Treasury bills returned 2.8% and inflation averaged 2.7%. Given these assumptions, what is the risk premium on corporate bonds? A) -0.1% B) 0.1% C) 2.6% D) 2.7% E) 2.8% Ans: C

Level: Basic

Subject: Risk Premium

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

129. Fred made the following rates of return on his portfolio over the past five years. The T-Bill rate and the inflation rate for each year are also shown. Based on this information, in which year did Fred have the highest real rate of return? Year 1 2 3 4 5 A) B) C) D) E)

Portfolio Return 11.00% 8.00% 16.00% 12.00% 9.00%

T-Bill rate 3.00% 4.00% 9.00% 6.00% 3.00%

Inflation Rate 5.00% 3.00% 11.00% 6.00% 2.00%

Year 1 Year 2 Year 3 Year 4 Year 5

Ans: E

Level: Basic

Subject: Real Rate Of Return

Type: Problems

130. Over the past four years a stock produced annual returns of 4%, -18%, - 21%, and 48%, respectively. Based on this information, what is the standard deviation for this stock? A) 18.03% B) 27.58% C) 31.85% D) 34.62% E) 55.16% Ans: C

Level: Intermediate

Subject: Standard Deviation

Type: Problems

131. Over the past five years a stock produced annual returns of 11%, 16%, 5%, 2%, and 9%, respectively. Based on this information, what is the standard deviation for this stock? A) 2.94% B) 3.88% C) 4.03% D) 5.09% E) 5.42% Ans: E

Level: Intermediate

Subject: Standard Deviation

Type: Problems

132. One year ago, Yokino purchased 100 shares of stock for $3,896. Since that time, he has received a total of $180 in dividends. If he sells the stock at today's market price he will realize a total return on his investment of 10.37%. Assuming he sells the stock today, what is the dollar amount of his capital gain per share of stock? A) $1.80 B) $2.24 C) $3.68 D) $4.04 E) $5.84 Ans: B

Level: Intermediate

Subject: Dollar Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

133. One year ago, Kyra purchased a ten-year 5% corporate bond for $986. The bond is currently selling for $1,002. If Kyra sells the bond today, what is the dollar amount of the total return she would realize on this investment? A) $14 B) $16 C) $34 D) $44 E) $66 Ans: E

Level: Intermediate

Subject: Dollar Return

Type: Problems

134. You purchased a stock one year ago for $91.20. Today you sold the stock and realized a total return of -63.7% on your investment. During the year you received a total of $2.28 in dividends. At what price did you sell the stock? A) $28.55 B) $30.83 C) $33.11 D) $55.81 E) $58.09 Ans: B

Level: Intermediate

Subject: Capital Gain And Dividend Yields

Type: Problems

135. You purchased a stock for $47.00 a share one year ago. Today you sold the stock for $50.21 a share and realized an 8.51% total rate of return. What was the dividend yield on this stock for the past year? A) 1.68% B) 1.71% C) 1.88% D) 2.03% E) 2.12% Ans: A

Level: Intermediate

Subject: Dividend Yield

Type: Problems

136. An investor purchased a stock for $1.61 per share, held it for one year, and sold it for $3.03 a share. The stock did not pay a dividend. Inflation for that year was 3.2% and the Canadian Treasury bill paid 3.7%. What is the real rate of return on this investment? A) 75.17% B) 82.36% C) 84.63% D) 85.00% E) 88.20% Ans: B

Level: Intermediate

Subject: Real Rate Of Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 28

Chapter 12 Some Lessons from Capital Market History

137. Suppose you have $30,000 invested in the stock market and your banker comes to you and tries to get you to move that money into the bank's Certificates of Deposit. He explains that the CDs are 100% government insured and that you are taking unnecessary risks by being in the stock market. How would you respond? Ans: The usual response is that bank CDs typically will offer a very low rate of return because of their low level of risk. Even if students do not know the relationship between yields on CDs and historical returns on stocks, they should recognize that because of the risk differences the CDs must have a lower expected return. So, if the investor in the question is willing to trade off some safety in order to have the chance to earn larger returns, the stock market is the correct investment. Level: Intermediate

Subject: Risk & Return

Type: Essays

138. Coming out of the depression, small stocks earned their highest one year historical return of 143% in 1933. However, in the four years prior to that you would have lost (going from 1929 to 1932, in order) about 50%, 40%, 50%, and 5%. Suppose you started into this five year stretch with $10,000 invested) How much did you still have heading into 1933? How much would you have at the end of that year? Based on these numbers, do you think the 143% return should be included in the return series? Ans: This question gives students the chance to convert returns into values and to see the impact of several years' losses on invested wealth. If you began with $10,000, your investment declines (year-byyear) to $5,000, $3,000, $1,500, and $1,425. So, you begin 1933 with only $1,425 left. At the end of that year, you have $3,463, a far cry from your starting point of $10,000. The astute student will point out that by the time the 143% return rolls around, the value of the investment has declined so much that the large single return in 1933 still leaves you far behind your initial investment. Small stocks are volatile and as such, you expect years of large losses and large gains, therefore no single year's return should be left out simply because it appears to be an outlier. Level: Intermediate

Subject: Returns on Small Stocks

Type: Essays

139. What are the lessons learned from capital market history? What evidence is there to suggest these lessons are correct? Ans: First, there is a reward for bearing risk, and second, the greater the reward, the greater the risk. As evidence, the students should provide a brief discussion of the historical rates of return and standard deviation of returns of the various asset classes discussed in the text. Level: Intermediate

Subject: Lessons

Type: Essays

140. Define the three forms of market efficiency. Ans: The student should present a straightforward discussion of weak (all past prices are in the current price), semi-strong (all public information is in the current price), and strong form (all information is in the current price) market efficiency. Level: Basic

Subject: Efficient Markets

Type: Essays

141. Explain why it is that in an efficient market, investments have an expected NPV of zero. Ans: In an efficient market, prices are "fair" so that the cost of an investment is neither too high nor too low. Thus, on average, investments in that market will yield a zero NPV. Investors get exactly what they pay for when they buy a security in an efficient market and firms get exactly what their stocks and bonds are worth when they sell them. Level: Intermediate

Subject: Efficient Markets

Type: Essays

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

142. Do you think the lessons from capital market history will hold for each year in the future? That is, as an example, if you buy small stocks will your investment always outperform Treasury bonds? Ans: The student should realize that we are working with averages, so they should not expect riskier assets to always outperform less risky assets. The student should explain somewhere in their answer that this gets to the heart of what risk is. That is, the reason you expect to earn a higher return over the long haul is that your variability in price from year to year can be significant. Level: Intermediate

Subject: Efficient Markets

Type: Essays

143. Suppose your cousin invests in the stock market and doubles her money in a single year while the market, on average, earned a return of only about 15%. Is your cousin's performance a violation of market efficiency? Ans: No, market efficiency does not preclude investors from "beating the market. " It is entirely possible to earn higher returns than the market at times. However, if your cousin is able to do so consistently, then there would certainly be some doubt cast upon market efficiency. Level: Intermediate

Subject: Market Efficiency

Type: Essays

144. How do you think the stock market would be affected if the laws were changed so that trading on insider information was no longer illegal? What would be the impact on the goal of the financial manager if such a change were to occur? Ans: This open-ended question allows students to ponder market efficiency from a different angle. By allowing insiders to trade on their information, it would be possible for insiders to take advantage of uninformed investors. This may keep some investors out of the market because they would perceive the prices observed as no longer being "fair. " This change would provide a serious blow to the efficiency of the market and would also further complicate the issue of who's interest managers are working to satisfy. Level: Challenge

Subject: Insider Trading

Type: Essays

145. Why should a financial decision maker such as a corporate treasurer or CFO be concerned with market efficiency? Ans: Good answers to this question might indicate that market efficiency is a necessary condition for the "Maximize Shareholder Wealth" rule. Unless we are confident that the market price is an economically meaningful number, seeking to maximize it is silly. Similarly, students should recognize that there is a very strong link between managerial decisions and the value of the firm, as reflected in security prices. Finally, as a preview of the cost of capital discussion in later chapters, instructors might point out that market efficiency ensures that the required returns on new securities will be directly related to the risk-return profile of the firm (and, therefore, to managerial actions). Level: Challenge

Subject: Market Efficiency

Type: Essays

146. Retirees with limited income and small investment portfolios are generally perceived as facing a real dilemma when it comes to investment risk and return. Explain this dilemma and what its implications are for the retirees. Ans: This question is designed to help students realize that higher rates of return also represent higher possibilities of investment losses, especially in the short-term. While retirees may need a high return, they cannot afford the short-term risk to their principal and therefore are generally forced to accept lower returns. Level: Intermediate

Subject: Risk And Return

Type: Essays

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

147. There is a common saying among investment professionals that "past performance does not guarantee future returns." If this statement is correct, then why is it important to understand the past performance of various asset classes? Ans: Student answers will vary. One general theme might be that history provides a basis for comparison along with a general understanding of the risk-return tradeoff. Historical performance also provides investors with some understanding of what they can reasonably expect to earn. These expectations affect the prices investors are willing to pay, thereby tending to keep the performance of an asset class within its historical averages. Level: Intermediate

Subject: Historical Rates Of Return

Type: Essays

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 31

View more...
Level: Basic

Subject: Total Returns

Type: Concepts

2. The total return on a security is made up of two components: the capital gains component and the price appreciation component. Ans: False

Level: Basic

Subject: Total Returns

Type: Concepts

3. In general, the longer the term of an investment the lower the risk premium will be. Ans: False

Level: Basic

Subject: Risk Premiums

Type: Concepts

4. On the basis of historical data from the 1948-2002 period, the return on the average Treasury bill has fluctuated more than the return on the average long bond. Ans: False

Level: Basic

Subject: Risk & Return

Type: Concepts

5. On the basis of historical data from the 1948-2002 period, the return on the average common stock has fluctuated less than the return on the average stock of small firms. Ans: True

Level: Basic

Subject: Risk & Return

Type: Concepts

6. A growth stock is a stock that results in a high return with relatively low levels of risk. Ans: False

Level: Basic

Subject: Growth Stocks

Type: Concepts

7. Generally speaking, financial markets are less efficient than real asset markets. Ans: False

Level: Basic

Subject: Efficient Markets

Type: Concepts

8. Your classmate just made $10,000 in a single day by trading in the stock market. It is reasonable to conclude, therefore, that the efficient market hypothesis cannot be true. Ans: False

Level: Basic

Subject: Efficient Markets

Type: Concepts

9. On most days, you notice that stock prices fluctuate wildly. It is obvious to you that markets are inefficient during this period. Ans: False

Level: Basic

Subject: Market Efficiency

Type: Concepts

10. Capital market efficiency is attributable largely to the lack of competition among market participants for information. Ans: False

Level: Basic

Subject: Efficient Markets

Type: Concepts

11. If insiders were allowed to profit on their inside information without penalty, financial markets would be less efficient. Ans: True

Level: Basic

Subject: Efficient Markets

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 1

Chapter 12 Some Lessons from Capital Market History

12. The excess return required on a risky asset over that earned on a risk-free asset is called a: A) Risk premium. B) Return premium. C) Excess return. D) Average return. E) Variance. Ans: A

Level: Basic

Subject: Risk Premiums

Type: Definitions

13. The average squared difference between the actual return and the average return is the: A) Average return. B) Variance. C) Standard deviation. D) Risk premium. E) Excess return. Ans: B

Level: Basic

Subject: Variance

Type: Definitions

14. The standard deviation for a set of stock returns can be calculated as: A) The positive square root of the average return. B) The average squared difference between the actual return and the average return. C) The positive square root of the variance. D) The average return divided by N minus one, where N is the number of returns. E) The variance squared. Ans: C

Level: Basic

Subject: Standard Deviation

Type: Definitions

15. A symmetric, bell-shaped statistical 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 Ans: D

Level: Basic

Subject: Normal Distribution

Type: Definitions

16. 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 Ontario Securities Commission) to be fair. E) Security prices reflect available information. Ans: E

Level: Basic

Subject: Efficient Capital Markets

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

17. The notion that actual capital markets, such as the TSX, 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. Ans: A

Level: Basic

Subject: Efficient Markets Hypothesis

Type: Definitions

18. The hypothesis that market prices reflect all available information is called efficiency in the: A) Open form. B) Strong form. C) Semi-strong form. D) Weak form. E) Stable form. Ans: B

Level: Basic

Subject: Strong Form Efficiency

Type: Definitions

19. The hypothesis that market prices reflect all publicly-available information is called efficiency in the: A) Open form. B) Strong form. C) Semi-strong form. D) Weak form. E) Stable form. Ans: C

Level: Basic

Subject: Semi-Strong Form Efficiency

Type: Definitions

20. The hypothesis that market prices reflect all historical information is called efficiency in the: A) Open form. B) Strong form. C) Semi-strong form. D) Weak form. E) Stable form. Ans: D

Level: Basic

Subject: Weak Form Efficiency

Type: Definitions

21. Risk premium is defined as: A) The total return on a risky asset that exceeds the inflation rate. B) The return on a risky asset that exceeds the return on a risk-free asset. C) The risk-free rate of return plus the inflation rate. D) The real rate of return that exceeds the risk-free rate of return. E) The rate of return required by investors in risky assets. Ans: B

Level: Basic

Subject: Risk Premium

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 3

Chapter 12 Some Lessons from Capital Market History

22. (Dt+1 / Pt) + [(Pt+1 – Pt)/ Pt] is the mathematical expression for the: A) Dividend yield. B) Capital gains yield. C) Total risk premium. D) Total rate of return. E) Real rate of return. Ans: D

Level: Basic

Subject: Total Return

Type: Definitions

23. The dollar rate of return on an investment can be mathematically defined as: A) (Dt+1 + Pt+1 - Pt) / Pt. B) (Dt + Pt+1 - Pt) / Pt. C) (Dt+1 / Pt) + (Pt+1 - Pt / Pt). D) Dt + Pt+1 - Pt. E) Dt+1 + Pt+1 - Pt. Ans: E

Level: Basic

Subject: Dollar Rate Of Return

Type: Definitions

24. The 95% probability range is defined as the: A) Risk premium plus or minus two times the standard deviation. B) Risk premium plus or minus two times the variance. C) Mean plus or minus two times the standard deviation. D) Mean plus or minus three times the standard deviation. E) Mean plus or minus three times the variance. Ans: C

Level: Basic

Subject: Probability Range

Type: Definitions

25. The square of the standard deviation is called the: A) Risk premium. B) Average rate of return. C) Excess return. D) Variance. E) Probability range. Ans: D

Level: Basic

Subject: Variance

Type: Definitions

26. The three probability ranges used with a normal distribution are defined as the _____ ranges. A) 75%, 85%, and 95% B) 68%, 75%, and 99% C) 68%, 85%, and 99% D) 68%, 85%, and 95% E) 68%, 95%, and 99% Ans: E

Level: Basic

Subject: Probability Ranges

Type: Definitions

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

27. For a stock that does not pay a dividend, the total return can also be defined as the: A) Risk premium plus the inflation rate. B) Capital gains rate. C) Real rate of return. D) Financial rate of return. E) Nominal after-tax rate of return. Ans: B

Level: Basic

Subject: Capital Gains Rate

Type: Definitions

28. A normal distribution is a statistical distribution that is defined by its: A) Probability ranges. B) Historical rates of return. C) Average rate of return and variance. D) Mean and standard deviation. E) Mean and capital gain ranges. Ans: D

Level: Basic

Subject: Normal Distribution

Type: Definitions

29. If a company insider uses all of her knowledge about the company stock and still has no advantage in the marketplace over outside investors, the market has to be: A) Semi-strong form efficient. B) Strong form efficient. C) Weak form efficient. D) Overpriced. E) Underpriced. Ans: B

Level: Basic

Subject: Strong Form Efficient

Type: Definitions

30. An efficient market is defined as one where all investments in that market are____ investments. A) Zero net present value B) Positive net present value C) Zero real rate of return D) Zero risk premium E) Positive real rate of return Ans: A

Level: Basic

Subject: Strong Form Efficient

Type: Definitions

31. An asset's return on investment has two components, one of which is ____________, which reflects the cash you receive directly while you own the investment. A) the capital gain B) the income component C) your reward for bearing risk D) your total dollar return E) your gross return on that investment Ans: B

Level: Basic

Subject: Income Component Of Return

Copyright © 2005 McGraw-Hill Ryerson Limited.

Type: Concepts

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Chapter 12 Some Lessons from Capital Market History

32. Which of the following correctly completes this sentence: When calculating your return on investment you should ignore _____________. A) paper gains which you could have obtained by cashing out B) losses you avoided by not buying a stock that has since decreased in price C) dividends that have been declared on the stock you own if you have not yet received the dividend D) paper capital losses that occur E) fees you are charged in the process of purchasing the asset in question Ans: B

Level: Basic

Subject: Components of Return

Type: Concepts

33. Last year you purchased 100 shares of Marvel Entertainment stock for $12 per share. According to today's quote in The National Post, the stock is currently selling for $18 per share. The stock pays no dividends. Your return on this investment is comprised of _____________________. A) an income return only B) an income return and a capital gains return C) a real return only D) a capital gains return only E) a dividend yield only Ans: D

Level: Basic

Subject: Capital Gains Return

Type: Concepts

34. Based on the historical record from 1948 to 2002, which of the following types of Canadian securities earned the SECOND highest return? A) Long bonds B) Small stocks C) Inflation D) Canadian Treasury bills E) Common stocks (S&P /TSX Composite) Ans: E

Level: Basic

Subject: Historical Returns

Type: Concepts

35. Which of the following investments have grown faster than the rate of inflation over the period 1948-2002? I. Canadian common stocks II. Treasury bills III. Long bonds IV. Small stocks A) I and III only B) I, II, and IV C) III and IV only D) I and II only E) I, II, III, and IV Ans: E

Level: Basic

Subject: Historical Returns

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

36. Over the past 50 years, which of the following Canadian investments has provided the largest average return? A) Canadian common stocks B) Inflation C) Treasury bills D) Long bonds E) Canadian small stocks Ans: E

Level: Basic

Subject: Historical Returns

Type: Concepts

37. Over the past 50 years, which of the following investments has provided the smallest average return? A) Canadian common stocks B) U.S. common stocks C) Treasury bills D) Long bonds E) Canadian small stocks Ans: C

Level: Basic

Subject: Historical Returns

Type: Concepts

38. Over the past 50 years, which of the following investments has been considered the most risky? A) Canadian common stocks B) U.S. common stocks C) Treasury bills D) Long bonds E) Canadian small stocks Ans: E

Level: Basic

Subject: Historical Risk

Type: Concepts

39. Over the past 50 years, which of the following investments has been the least risky? A) Canadian common stocks B) U.S. common stocks C) Treasury bills D) Long bonds E) Canadian small stocks Ans: C

Level: Basic

Subject: Historical Risk

Type: Concepts

40. Which of the following statements about historical security returns is/are true? I. Stocks of small companies have higher average returns than those of larger companies. II. Risky securities have higher average returns than riskless securities. III. Long bonds have higher average yields than Treasury bills. IV. Historical information about capital markets is useful for drawing conclusions about the relationship between risk and return. A) I and III only B) I, II, and III only C) III and IV only D) I and II only E) I, II, III, and IV Ans: E

Level: Basic

Subject: Historical Returns

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

41. Why do long-term government bonds have a risk premium? A) They are not default-free. B) They are virtually identical to long-term corporate bonds. C) The government cannot easily raise tax money to repay the bonds. D) The long time period to maturity. E) Long-term government bonds don't have a risk premium. Ans: D

Level: Basic

Subject: Long-Term Government Bonds

Type: Concepts

42. Which of the following is true about risk and return? A) Riskier assets will, on average, earn lower returns. B) The reward for bearing risk is known as the standard deviation. C) Based on historical data, there is no reward for bearing risk. D) An increase in the risk of an investment will result in a decreased risk premium. E) In general, the higher the risk the higher the expected return. Ans: E

Level: Basic

Subject: Risk & Return

Type: Concepts

43. Which of the following is true? A) Risky assets on average do not earn a risk premium. B) There is a reward for bearing risk, on average. C) On average, the greater the risk, the lower the reward. D) When comparing the common stock of two firms, the riskier one will have the lower price. E) If a market is not efficient, then all assets in that market will have the same reward to risk ratio. Ans: B

Level: Basic

Subject: Risk Premiums

Type: Concepts

44. Which of the following is likely to be associated with the highest level of risk? A) Long-term corporate bonds B) Canadian Treasury bills C) Long-term government bonds D) Common stock of the largest companies in Canada E) Common stock of the smallest companies listed on the TSX Ans: E

Level: Basic

Subject: Investment Risk

Type: Concepts

45. Which of the following is generally considered to represent the risk-free return? A) Common stocks B) Treasury bills C) Small stocks D) Long bonds E) Inflation Ans: B

Level: Basic

Subject: Risk-Free Return

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

46. Over the 1957-2002 period, the risk premium on long bonds has averaged ________ per year. A) 0.0% B) 1.6% C) 2.1% D) 9.4% E) 13.6% Ans: C

Level: Basic

Subject: Risk Premiums

Type: Concepts

47. Over the 1957-2002 period, the risk premium on small stocks has averaged ________ per year. A) 0.0% B) 1.95% C) 2.35% D) 6.42% E) 13.65% Ans: D

Level: Basic

Subject: Risk Premiums

Type: Concepts

48. Over the 1957-2002 period, the risk premium on Canadian common stocks has averaged ______ per year. A) 0.0% B) 1.96% C) 2.36% D) 3.40% E) 13.66% Ans: D

Level: Basic

Subject: Risk Premiums

Type: Concepts

49. You are considering two investments. You note that the return on investment A tends to vary quite widely from its average, definitely more so than does investment B. Based on this, you believe that: A) A has a lower variance than B. B) A has a lower standard deviation than B. C) A has a higher inflation premium than B. D) A has a higher return volatility than B. E) A must be stock in one of the largest Canadian firms while B must be stock in one of the smallest firms listed on the TSX Ans: D

Level: Basic

Subject: Variance

Type: Concepts

50. _________________ is one of the most commonly used measures of return volatility. A) The normal distribution B) The inflation rate C) The risk premium D) Standard deviation E) Return on investment Ans: D

Level: Basic

Subject: Volatility

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

51. Over the 1957-2002 period, the standard deviation of returns for Canadian common stocks has averaged _________ per year. A) 3.22% B) 8.62% C) 9.22% D) 16.41% E) 33.28% Ans: D

Level: Basic

Subject: Historical Volatility

Type: Concepts

52. Over the 1957-2002 period, the standard deviation of returns for small stocks has averaged ______________ per year. A) 3.28% B) 8.68% C) 9.28% D) 20.38% E) 23.05% Ans: E

Level: Basic

Subject: Historical Volatility

Type: Concepts

53. Over the 1957-2002 period, the standard deviation of returns for long bonds has averaged ___________ per year. A) 3.27% B) 8.67% C) 10.47% D) 20.37% E) 33.87% Ans: C

Level: Basic

Subject: Historical Volatility

Type: Concepts

54. The normal distribution is useful in analyzing security returns because: A) We frequently deal with finite data sets. B) Of its bell-shaped appearance. C) 95% of all observations fall within two standard deviations of the mean. D) The distribution of security returns is usually different from a normal distribution. E) It can be completely described by its mean and standard deviation. Ans: E

Level: Basic

Subject: Normal Distribution

Type: Concepts

55. The lessons from capital market history tell us: I. There is a reward for bearing risk. II. The greater the potential reward from a risky asset, the greater is the risk. III. The TSX is an inefficient market. A) I only B) II only C) I and II only D) I and III only E) I, II, and III Ans: C

Level: Basic

Subject: Capital Market History

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

56. If capital markets are efficient, then ________________________. A) there is no reason to believe that prices are too high or too low B) it is possible to profit regularly from publicly available information C) prices will adjust slowly when reacting to new information D) it is not possible to make money by playing the stock market E) historical price trends will give you a good idea of where prices are headed in the future Ans: A

Level: Basic

Subject: Efficient Markets

Type: Concepts

57. Which of the following is NOT correct with regards to the Efficient Markets Hypothesis? A) The EMH suggests that there are no positive NPV investments, on average. B) The EMH asserts that information has been "priced out" of stocks. C) The EMH refers to well-organized capital markets. D) The EMH suggests that the prices on the TSX are fair, on average. E) The EMH suggests that markets in which prices fluctuate a great deal cannot be efficient. Ans: E

Level: Basic

Subject: Efficient Markets

Type: Concepts

58. Which form(s) of market efficiency is/are generally considered to hold in well-organized markets? I. Strong form efficiency II. Semi-strong form efficiency III. Weak form efficiency A) I only B) II only C) III only D) I and II only E) II and III only Ans: E

Level: Basic

Subject: Efficient Markets

Type: Concepts

59. Which of the following is implied by the evidence regarding market efficiency? A) Prices in well-organized capital markets are unfair. B) There is a simple way to identify mispriced stocks when they exist. C) Prices don't respond rapidly to new information. D) It is difficult to predict future price movements based on public information. E) Insiders cannot make money from their private information. Ans: D

Level: Basic

Subject: Efficient Markets

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

60. Assume that markets are semi-strong form efficient. Suppose, then, that during a trading day, important new information is released for the first time concerning a certain company. This information indicates that one of the firm's oil fields, previously thought to be very promising, just came up dry. How would you expect the price of a share of stock to react to this information? A) The value of a share will fall over an extended period of time as investors begin to sell shares in the company. B) The value of a share will drop immediately to a price that reflects the value of the new information. C) The value of a share will fall below what is considered appropriate because of the decreased demand for the shares, but eventually the price will rise to the correct level. D) The value of a share will rise over a long period of time as investors sell the stock. E) The stock price will not change since this type of information has no impact in markets that are semistrong form efficient. Ans: B

Level: Basic

Subject: Efficient Markets

Type: Concepts

61. IBM announces that earnings per share for the current quarter are $1.25; this figure is barely half of what investors and analysts expected. In an efficient market, the price of IBM stock will A) change immediately to reflect changes in investor expectations B) gradually fall over several days as investors assimilate the new information C) first fall, reflecting investors' surprise; then rise back somewhat as investors assimilate the new information D) probably not change at all E) fall only if there is additional unfavourable news about IBM announced at the same time Ans: A

Level: Basic

Subject: Efficient Markets

Type: Concepts

62. Suppose you purchase a stock expecting the price to rise in the coming year. After one year, your stock has actually decreased in value, due primarily to adverse information released during the year. Which of the following describes this result? A) This is not a violation of market efficiency. B) This is a violation of weak form efficiency. C) This is a violation of semi-strong form efficiency. D) This is a violation of strong form efficiency. E) This is a violation of all forms of market efficiency. Ans: A

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

63. You discover that you can make greater than expected returns by buying stock in firms whenever the growth rate in sales predicted by an investment survey exceeds the stock's current price-earnings ratio. Which of the following describes this event? A) This would not be a violation of market efficiency. B) This would be a violation of weak form efficiency. C) This would be a violation of semi-strong form efficiency but not of weak form efficiency. D) This would be a violation of strong form efficiency but not of semi-strong form efficiency. E) This would be a violation of all forms of market efficiency. Ans: C

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

64. You discover you can make above normal returns if you buy oil-company stocks just before noon on any given trading day and then sell them immediately before the market closes that same day. Which of the following describes this event? A) This would not be a violation of market efficiency. B) This would be a violation of weak form efficiency. C) This would be a violation of semi-strong form efficiency. D) This would be a violation of strong form efficiency. E) This would be a violation of all forms of market efficiency. Ans: B

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

65. An efficient market implies _________________________. A) that, on average, all investments have a negative NPV B) that, on average, all investments have a zero NPV C) that, on average, all investments have a positive NPV D) that there tend to be more positive NPV investments than negative NPV investments E) Nothing about the NPV of an investment Ans: B

Level: Basic

Subject: Efficient Markets

Type: Concepts

66. Which of the following statements about market efficiency is generally considered to be true? A) For inefficient markets, security prices will rapidly reflect new information. B) It is easy to forecast the direction of future security price changes in the short run. C) Short-run price changes occur independent of information coming to the market. D) On average, most stocks are mispriced. E) In the absence of legal constraints, investors with inside information will be able to earn excess returns. Ans: E

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

67. Which of the following is NOT correct about market efficiency? A) The EMH says that actual capital markets, such as the TSX, are efficient. B) Strong form efficiency says all information of any kind is reflected in stock prices. C) Semi-strong form efficiency says all public and private information is reflected in stock prices. D) Weak form efficiency says studying past prices in an attempt to identify mispriced stocks is futile. E) The price a firm obtains when it sells its stock in an efficient market is a fair price, in the sense that the price reflects available information about the stock. Ans: A

Level: Intermediate

Subject: Market Efficiency

Type: Concepts

68. You have discovered from looking at charts of past stock prices that if you buy just after a stock price has declined for three consecutive days, you make money every time! This is a violation of ________ market efficiency. A) weak form B) semi-weak form C) semi-strong form D) strong form E) TSX stock Ans: A

Level: Intermediate

Subject: Efficient Markets

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

69. In efficient markets, investments have which of the following attributes? I. Expected return equal to zero II. Expected NPV equal to zero III. Expected risk premium equal to zero A) I only B) II only C) I and II only D) I and III only E) II and III only Ans: B

Level: Basic

Subject: Efficient Markets

Type: Concepts

70. Driving in your car, you hear that Microsoft has announced that they have cornered the market on Internet technology. Knowing this is great news for Microsoft, when you arrive at a phone 30 minutes later you call your broker and are able to buy Microsoft stock before its price moves up on the news. This is a violation of ___________ market efficiency. A) weak form B) semi-weak form C) semi-strong form D) strong form E) TSX stock Ans: C

Level: Basic

Subject: Efficient Markets

Type: Concepts

71. While eating in an exclusive restaurant in New York City, you overhear two executives negotiating a merger. When you check the news about the two companies after lunch you find there is no public information about any merger. Thus, you buy shares of stock in both firms and make a killing when the merger is announced publicly two days later. This is a violation of ______________ market efficiency. A) weak form B) semi-weak form C) semi-strong form D) strong form E) TSX stock Ans: D

Level: Basic

Subject: Efficient Markets

Type: Concepts

72. The market return on the Canadian Treasury bill is generally used as the measure of the: A) Real rate of market return. B) Real rate of return on a risk-free investment. C) Nominal risk premium rate of return. D) Risk-free rate of return. E) Risk premium on government bonds. Ans: D

Level: Basic

Subject: Risk-Free Rate Of Return

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

73. The nominal rate of return on large-company stocks consists of a: A) Risk-free rate of return plus an inflation adjustment. B) Real rate of return plus the Treasury bill rate of return. C) Risk premium plus the Treasury bill rate of return. D) Risk-free rate of return plus a bond premium. E) Real risk-free rate of return plus a risk premium. Ans: C

Level: Intermediate

Subject: Risk Premium

Type: Concepts

74. Which of the following are included in the market prices if the market is semi-strong efficient? I. All historical information II. All insider information III. All public information IV. All information of any kind A) I only B) III only C) I and III only D) I, II, and III only E) I, II, III, and IV Ans: C

Level: Intermediate

Subject: Semi-strong Efficiency

Type: Concepts

75. If the stock market is weak form efficient, then an investor can NOT earn excess profits by: A) Trading on insider information. B) Trading on newly released public information. C) Identifying mispriced securities. D) Studying historical price patterns. E) Studying financial statements as they become available. Ans: D

Level: Intermediate

Subject: Weak Form Efficiency

Type: Concepts

76. If a market is efficient, then the difference between the market value of an investment and its cost is: A) Zero. B) Positive and greater than 1. C) Equal to the risk premium. D) Equal to the net present value of the cash inflows. E) Equal to the risk-free rate of return. Ans: A

Level: Basic

Subject: Market Efficiency

Type: Concepts

77. Last year you purchased a stock at $21.63 a share. Today you sold your shares at $23.01 after receiving your quarterly dividend. The total return on this stock consists of: A) A capital gain only. B) A capital loss only. C) A capital gain and a dividend yield. D) A capital loss and a dividend yield. E) A dividend yield and a risk-free rate of return. Ans: C

Level: Intermediate

Subject: Total Return

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

78. Which one of the following has the highest risk premium based on historical information? A) Canadian Treasury bill B) Corporate bonds C) Large-company stocks D) Government bonds E) Small-company stocks Ans: E

Level: Intermediate

Subject: Risk Premium

Type: Concepts

79. Historical information has shown that there is ______ relationship between the rate of return and the risk of an investment. A) No B) An indirect C) A random D) A direct E) An inverse Ans: D

Level: Basic

Subject: Risk And Return

Type: Concepts

80. You are an investor who studies the price movements of stock to identify patterns that are repetitive. By doing this, you have been able to earn higher returns than normal. This would be a violation of: A) The risk-return tradeoff. B) The normal risk premium reward. C) Strong form efficiency. D) Semi-strong form efficiency. E) Weak form efficiency. Ans: E

Level: Intermediate

Subject: Weak Form Efficiency

Type: Concepts

81. The higher the standard deviation of a stock the: A) Greater the probability of losing more than 50% of your investment in any one year. B) Lower the risk premium given a normal market. C) Lower the volatility level over a period of time. D) Narrower the bell curve and the smaller the probability ranges. E) Greater the probability that the actual return for any one year will equal the average historical return. Ans: A

Level: Intermediate

Subject: Standard Deviation

Type: Concepts

82. Which one of the following types of investments would be associated with the narrowest bell curve? A) Large-company stocks B) Corporate bonds C) Long-term government bonds D) Small-company stocks E) Treasury bills Ans: E

Level: Basic

Subject: Bell Curve

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

83. Which of the following statements concerning probability ranges of a normal distribution is (are) correct? I. The 99% probability range is equal to the mean plus or minus three times the variance. II. With a mean of 5% and a standard deviation of 10%, the probability of earning more than 25% in any one year is no more than 2.5%. III. If the lowest return for a 68% probability range is -21%, then there is a 32% chance that the loss in any one year will be greater than 21%. IV. The mean is equal to the average variance of an investment over a period of time. A) I only B) II only C) I and III only D) II and IV only E) II, III, and IV only Ans: B

Level: Intermediate

Subject: Probability Ranges

Type: Concepts

84. The variance is the: A) Average risk premium over a period of time. B) Average of the squared deviations from the mean. C) Total of the squared deviations from the average. D) Positive square root of the standard deviation. E) Average difference between the actual return and the average return. Ans: B

Level: Intermediate

Subject: Variance

Type: Concepts

85. Which one of the following categories has the lowest positive, non-zero, risk premium? A) Large-company stocks B) Long-term government bonds C) Small-company stocks D) Treasury bills E) Long-term corporate bonds Ans: B

Level: Basic

Subject: Risk Premium

Type: Concepts

86. Which one of the following statements is true concerning market performance over the period 1957-2002? A) Over the short-term, small-company stocks are less volatile than large-company stocks. B) Canadian Treasury bills tend to pay a higher rate of return than do long-term government bonds. C) Canadian Treasury bills have paid returns in excess of 10% in some years. D) Over the long-term, large-company stocks outperform small-company stocks. E) Canadian Treasury bills always have a positive real rate of return. Ans: C

Level: Intermediate

Subject: Historical Performance

Type: Concepts

87. The historical record demonstrates that the risk of loss decreases when the _____ increases. A) Time horizon B) Standard deviation C) Variance D) Volatility E) Average return Ans: A

Level: Intermediate

Subject: Holding Period

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

88. Which of the following statements is (are) true concerning risk and return? I. To accept higher levels of risk, investors must be paid a higher risk premium. II. Small-company stocks offer a higher return and less risk than large-company stocks. III. The risk-free rate of return is based on the long-term government bond rate. IV. The higher the standard deviation, the less predictable the rate of return in any one year. A) I only B) II only C) III and IV only D) I and II only E) I and IV only Ans: E

Level: Intermediate

Subject: Risk And Return

Type: Concepts

89. The frequency distribution of large-company stocks since 1948 shows that: A) These stocks have never lost more than 30% of their value in any one year. B) These stocks have never produced a rate of return higher than 40% in any one year. C) These stocks tend to have a normal distribution around a positive mean over the long-term. D) These stocks return negative rates of return about half of the time. E) There is minimal risk in these stocks over the short-term. Ans: C

Level: Intermediate

Subject: Frequency Distribution

Type: Concepts

90. The total of the deviations of actual returns from the average return will: A) Always be positive and greater than zero. B) Sometimes be positive and sometimes be negative. C) Always be equal to zero. D) Always be greater than the average return. E) Be greater the larger the degree of volatility. Ans: C

Level: Intermediate

Subject: Deviation

Type: Concepts

91. Which one of the following statements is correct concerning the historical standard deviations of asset classes over the period 1957-2002? A) The standard deviation of small-company stocks is almost three times the average annual return for those stocks. B) The standard deviation of large-company stocks demonstrates they have more risk than any other category. C) The historical standard deviation of long-term corporate bonds is less than the standard deviation of large-company stocks. D) Long-term corporate bonds are more volatile than Canadian Treasury bills as shown by their standard deviations. E) The historical standard deviation of large-company stocks is greater than the standard deviation of small-company stocks. Ans: D

Level: Intermediate

Subject: Standard Deviation

Type: Concepts

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

92. You purchased a bond on January 1, 2002 for $839.67. The bond has a $1,000 face value, an 8% annual coupon, and can be sold for $842.33 on December 31, 2002. What is your total dollar return for the year? A) $2.66 B) $10.66 C) $72.34 D) $77.34 E) $82.66 Ans: E

Level: Basic

Subject: Dollar Return

Type: Problems

93. You purchased 200 shares of preferred stock on January 1, 2002 for $42.27 per share. The stock pays an annual dividend of $7 per share. On December 31, 2002 the market price is $46.88 per share. What is your total dollar return for the year? A) $478 B) $922 C) $1,400 D) $2,322 E) $2,678 Ans: D

Level: Basic

Subject: Dollar Return

Type: Problems

94. You purchased a bond on January 1, 2002 for $839.67. The bond has a $1,000 face value, an 8% annual coupon, and can be sold for $822.33 on December 31, 2002. What is your percentage return on investment for the year? A) -2.1% B) 7.5% C) 8.6% D) 11.6% E) 11.8% Ans: B

Level: Basic

Subject: Percentage Return

Type: Problems

95. You purchased 200 shares of preferred stock on January 1, 2002 for $42.27 per share. The stock pays an annual dividend of $5 per share. On December 31, 2002 the market price is $43.88 per share. What is your percentage return on investment for the year? A) 4.9% B) 8.0% C) 14.9% D) 15.1% E) 15.6% Ans: E

Level: Basic

Subject: Percentage Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

96. You purchased a bond for $900 one year ago. Today, you receive your only interest payment for the year of $100. The bond can currently be sold for $975. What is your total percentage return on investment? Ignore tax effects. A) 8.3% B) 11.1% C) 18.0% D) 19.4% E) 23.8% Ans: D

Level: Basic

Subject: Investment Returns

Type: Problems

97. An investment earned the following returns for the years 2000 through 2003:-20%, 50%, 30%, and 10%. What is the variance of returns for this investment? A) 0.0892 B) 0.1121 C) 0.1541 D) 0.1747 E) 0.2987 Ans: A

Level: Basic

Subject: Variance

Type: Problems

98. Given the following historical returns, what is the variance? Year 1 = 8%; year 2 = -12%; year 3 = 6%; year 4 = 1%; year 5 = -19%. A) 0.0063 B) 0.0089 C) 0.0139 D) 0.0394 E) 0.1178 Ans: C

Level: Basic

Subject: Variance

Type: Problems

99. Given the following historical returns, what is the standard deviation? Year 1 = 20%; year 2 = -12%; year 3 = 16%; year 4 = 3%; year 5 = -15%. A) 11.89% B) 12.48% C) 14.18% D) 15.85% E) 16.87% Ans: D

Level: Basic

Subject: Standard Deviation

Type: Problems

100. Given the following returns, what is the variance? Year 1 = 15%; year 2 = 3%; year 3 = -29%; year 4 = -1%. A) 0.0137 B) 0.0182 C) 0.0347 D) 0.0398 E) 0.0468 Ans: C

Level: Basic

Subject: Variance

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

101. Over the last three years you earned 5%, 7%, and 9%. What is the standard deviation of your returns? A) 0.8% B) 1.6% C) 2.0% D) 2.3% E) 2.9% Ans: C

Level: Basic

Subject: Standard Deviation

Type: Problems

102. Which of the following two stocks is more volatile based on their historical returns? Year 1 2 3 4 5 Return A .04 .06 .08 .10 .12 Return B .08 .09 .10 .11 .12 A) B) C) D) E)

A because it has a lower mean B because it has a higher mean A because it has a higher standard deviation B because it has a lower standard deviation B because it has a higher variance

Ans: C

Level: Basic

Subject: Historical Volatility

Type: Problems

103. If we assume that the annual return on common stocks are normally distributed, then approximately 95% of the returns will fall within the range ___________% if the average historical return is 13.2% with a standard deviation of 20.3%. A) 7.1 to 33.5 B) -7.1 to 33.5 C) -27.4 to 33.5 D) -5.1 to 45.7 E) -27.4 to 53.8 Ans: E

Level: Basic

Subject: Normal Distribution

Type: Problems

Use the following to answer questions 104-107: You purchase 100 shares of stock at a price of $45 per share. One year later, the shares are selling for $47 per share. In addition, a dividend of $4 per share is paid at the end of each year. 104. What is the total dollar return for the investment? A) $400 B) $500 C) $600 D) $800 E) $1,200 Ans: C

Level: Basic

Subject: Total Dollar Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

105. What is the capital gains yield for the investment? A) 4.4% B) 5.5% C) 8.5% D) 8.9% E) 13.3% Ans: A

Level: Basic

Subject: Capital Gains Yield

Type: Problems

106. What is the dividend yield for the investment? A) 4.4% B) 5.5% C) 8.5% D) 8.9% E) None of the above. Ans: D

Level: Basic

Subject: Dividend Yield

Type: Problems

107. What is the total percentage return for the investment? A) 5.5% B) 8.5% C) 8.9% D) 12.8% E) 13.3% Ans: E

Level: Basic

Subject: Percentage Return

Type: Problems

Use the following to answer questions 108-111: You purchased 500 shares of a stock at a price of $22.50 per share. One year later, the shares sold for $21 each. At that end of the year, a $1.50 per share dividend was paid. 108. What is the total dollar return for the investment? A) $0 B) $750 C) $1,250 D) $1,500 E) $1,750 Ans: A

Level: Basic

Subject: Total Dollar Return

Type: Problems

109. What is the capital gains yield for the investment? A) -7.1% B) -6.7% C) 0.0% D) 6.7% E) 7.1% Ans: B

Level: Basic

Subject: Capital Gains Yield

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

110. What is the dividend yield for the investment? A) -7.1% B) -6.7% C) 0.0% D) 6.7% E) 7.1% Ans: D

Level: Basic

Subject: Dividend Yield

Type: Problems

111. What is the total percentage return for the investment? A) -7.1% B) -6.7% C) 0.0% D) 6.7% E) 7.1% Ans: C

Level: Basic

Subject: Percentage Return

Type: Problems

Use the following to answer questions 112-116: Use the following historical average returns and standard deviations to answer the question(s) below. Asset Average Return Standard Deviation Canadian common stocks 13.20% 16.62% US common stocks 15.59% 16.86% Long bonds 7.64% 10.57% Small-company stocks 14.79% 23.68% Treasury bills 6.04% 4.04%

112. What is the historical risk premium on Canadian common stocks? A) 0% B) 7.16% C) 9.55% D) 1.60% E) 8.75% Ans: B

Level: Basic

Subject: Risk Premiums

Type: Problems

113. What is the historical risk premium of Canadian common stocks over long bonds? A) 7.15% B) 7.16% C) 5.56% D) 1.60% E) 8.75% Ans: C

Level: Basic

Subject: Risk Premiums

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

114. Based on the historical data above, what is your reward for bearing risk of owning small-company stocks rather than Canadian common stocks? A) 1.59% B) 0.80% C) 2.39% D) 1.60% E) 4.25% Ans: A

Level: Basic

Subject: Risk Premiums

Type: Problems

115. If the returns on small-company stocks are normally distributed, which of the following returns would lie in a 99% confidence interval around the mean, but not in a 95% confidence interval? A) -30% B) -10% C) 50% D) 70% E) 90% Ans: D

Level: Intermediate

Subject: Normal Distribution

Type: Problems

116. Assume the return on T-bills is normally distributed. Assuming a 68% probability, what is the highest return you would expect to earn on T-bills? A) 2.00% B) 4.04% C) 6.04% D) 10.08% E) 14.12% Ans: D

Level: Intermediate

Subject: Normal Distribution

Type: Problems

117. Marti purchased a stock one year ago at a price of $23.89. Over the past year she has received a total of $1.63 in dividends. Today she sold the stock for $22.84. What percentage total return did Marti earn on this investment? A) 2.43% B) 2.54% C) 4.40% D) 6.82% E) 7.14% Ans: A

Level: Basic

Subject: Total Return

Type: Problems

118. Sam purchased a stock for $46.91 one year ago. Today he sold the stock for $48.03. The stock paid a total of $1.40 in dividends over the year. What capital gains yield did Sam realize on this investment? A) 2.33% B) 2.39% C) 2.67% D) 3.13% E) 5.37% Ans: B

Level: Basic

Subject: Capital Gains Yield

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

119. Frederico paid $86.70 for a stock one year ago. Today he sold the stock for $88.20. Over the year, Frederico received four quarterly dividends of $0.60 each. What was the dividend yield on this investment? A) 0.69% B) 1.02% C) 2.77% D) 4.42% E) 4.50% Ans: C

Level: Basic

Subject: Dividend Yield

Type: Problems

120. A stock produced total returns of 10.4%, -11.9%, - 21.7%, and 31.2% over the past four years, respectively. What is the average rate of return for this period of time? A) 1.50% B) 1.67% C) 2.00% D) 2.34% E) 2.67% Ans: C

Level: Basic

Subject: Average Rate Of Return

Type: Problems

121. A stock produced total returns of 9.78%, 13.61%, 1.19%, and -4.90% over the past four years, respectively. What is the variance on this set of returns? A) 0.70% B) 0.88% C) 1.38% D) 1.63% E) 2.09% Ans: A

Level: Basic

Subject: Variance

Type: Problems

122. You purchased a five-year 6% annual coupon bond one year ago for $990. You sold the bond today when the market rate of return is 4.5%. If the inflation rate for the past year was 2.0%, what nominal rate of return did you earn on this investment? A) 7.07% B) 8.16% C) 10.30% D) 11.67% E) 12.51% Ans: E

Level: Intermediate

Subject: Nominal Rate Of Return

Type: Problems

123. Angelo purchased a 7% annual coupon bond one year ago for $987. At the time of purchase, the bond had six years to maturity. Over the past year inflation has been 3.2%. The market required return on this bond today is 8%. If Angelo sells the bond today at the market price, what real rate of return will he realize on this investment? A) -1.16% B) 1.13% C) 1.17% D) 4.33% E) 4.36% Ans: B

Level: Intermediate

Subject: Real Rate Of Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

124. A stock produced total returns of 11.5%, 8.3%, and -2.4% over the past three years, respectively. Based on this information what range of returns would you expect to see 95% of the time? A) -36.70% to 25.10% B) -26.40% to 14.80% C) -14.80% to 26.40% D) -25.10% to 36.70% E) -35.40% to 47.00% Ans: D

Level: Intermediate

Subject: Probability Distributions

Type: Problems

125. ABC stock pays a $1.80 annual dividend. The market price of the stock was $21.74, $19.83, $22.60, and $23.10 at the end of the past four years, respectively. Based on this information, what is the mean rate of return? A) 9.67% B) 10.91% C) 11.25% D) 19.14% E) 21.82% Ans: B

Level: Intermediate

Subject: Mean Rate Of Return

Type: Problems

126. A stock has an average rate of return of 11.5% and a standard deviation of 12.8%. What is the probability that the stock will lose more than 26.9% in any one year? A) 0.50% B) 1.00% C) 1.25% D) 2.50% E) 5.00% Ans: A

Level: Intermediate

Subject: Probability Distributions

Type: Problems

127. Over the past three years, a stock has produced capital gains of 3.6%, 42.9%, and -18.6%, respectively. The stock does not pay a dividend. Based on this information what is the approximate probability than the stock will double in value in any one year? A) 0.0% B) 0.5% C) 1.0% D) 2.5% E) 5.0% Ans: B

Level: Intermediate

Subject: Probabilty Distributions

Type: Problems

128. Assume that for some period of time corporate bonds had an average rate of return of 5.4% while Treasury bills returned 2.8% and inflation averaged 2.7%. Given these assumptions, what is the risk premium on corporate bonds? A) -0.1% B) 0.1% C) 2.6% D) 2.7% E) 2.8% Ans: C

Level: Basic

Subject: Risk Premium

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

129. Fred made the following rates of return on his portfolio over the past five years. The T-Bill rate and the inflation rate for each year are also shown. Based on this information, in which year did Fred have the highest real rate of return? Year 1 2 3 4 5 A) B) C) D) E)

Portfolio Return 11.00% 8.00% 16.00% 12.00% 9.00%

T-Bill rate 3.00% 4.00% 9.00% 6.00% 3.00%

Inflation Rate 5.00% 3.00% 11.00% 6.00% 2.00%

Year 1 Year 2 Year 3 Year 4 Year 5

Ans: E

Level: Basic

Subject: Real Rate Of Return

Type: Problems

130. Over the past four years a stock produced annual returns of 4%, -18%, - 21%, and 48%, respectively. Based on this information, what is the standard deviation for this stock? A) 18.03% B) 27.58% C) 31.85% D) 34.62% E) 55.16% Ans: C

Level: Intermediate

Subject: Standard Deviation

Type: Problems

131. Over the past five years a stock produced annual returns of 11%, 16%, 5%, 2%, and 9%, respectively. Based on this information, what is the standard deviation for this stock? A) 2.94% B) 3.88% C) 4.03% D) 5.09% E) 5.42% Ans: E

Level: Intermediate

Subject: Standard Deviation

Type: Problems

132. One year ago, Yokino purchased 100 shares of stock for $3,896. Since that time, he has received a total of $180 in dividends. If he sells the stock at today's market price he will realize a total return on his investment of 10.37%. Assuming he sells the stock today, what is the dollar amount of his capital gain per share of stock? A) $1.80 B) $2.24 C) $3.68 D) $4.04 E) $5.84 Ans: B

Level: Intermediate

Subject: Dollar Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

133. One year ago, Kyra purchased a ten-year 5% corporate bond for $986. The bond is currently selling for $1,002. If Kyra sells the bond today, what is the dollar amount of the total return she would realize on this investment? A) $14 B) $16 C) $34 D) $44 E) $66 Ans: E

Level: Intermediate

Subject: Dollar Return

Type: Problems

134. You purchased a stock one year ago for $91.20. Today you sold the stock and realized a total return of -63.7% on your investment. During the year you received a total of $2.28 in dividends. At what price did you sell the stock? A) $28.55 B) $30.83 C) $33.11 D) $55.81 E) $58.09 Ans: B

Level: Intermediate

Subject: Capital Gain And Dividend Yields

Type: Problems

135. You purchased a stock for $47.00 a share one year ago. Today you sold the stock for $50.21 a share and realized an 8.51% total rate of return. What was the dividend yield on this stock for the past year? A) 1.68% B) 1.71% C) 1.88% D) 2.03% E) 2.12% Ans: A

Level: Intermediate

Subject: Dividend Yield

Type: Problems

136. An investor purchased a stock for $1.61 per share, held it for one year, and sold it for $3.03 a share. The stock did not pay a dividend. Inflation for that year was 3.2% and the Canadian Treasury bill paid 3.7%. What is the real rate of return on this investment? A) 75.17% B) 82.36% C) 84.63% D) 85.00% E) 88.20% Ans: B

Level: Intermediate

Subject: Real Rate Of Return

Type: Problems

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

137. Suppose you have $30,000 invested in the stock market and your banker comes to you and tries to get you to move that money into the bank's Certificates of Deposit. He explains that the CDs are 100% government insured and that you are taking unnecessary risks by being in the stock market. How would you respond? Ans: The usual response is that bank CDs typically will offer a very low rate of return because of their low level of risk. Even if students do not know the relationship between yields on CDs and historical returns on stocks, they should recognize that because of the risk differences the CDs must have a lower expected return. So, if the investor in the question is willing to trade off some safety in order to have the chance to earn larger returns, the stock market is the correct investment. Level: Intermediate

Subject: Risk & Return

Type: Essays

138. Coming out of the depression, small stocks earned their highest one year historical return of 143% in 1933. However, in the four years prior to that you would have lost (going from 1929 to 1932, in order) about 50%, 40%, 50%, and 5%. Suppose you started into this five year stretch with $10,000 invested) How much did you still have heading into 1933? How much would you have at the end of that year? Based on these numbers, do you think the 143% return should be included in the return series? Ans: This question gives students the chance to convert returns into values and to see the impact of several years' losses on invested wealth. If you began with $10,000, your investment declines (year-byyear) to $5,000, $3,000, $1,500, and $1,425. So, you begin 1933 with only $1,425 left. At the end of that year, you have $3,463, a far cry from your starting point of $10,000. The astute student will point out that by the time the 143% return rolls around, the value of the investment has declined so much that the large single return in 1933 still leaves you far behind your initial investment. Small stocks are volatile and as such, you expect years of large losses and large gains, therefore no single year's return should be left out simply because it appears to be an outlier. Level: Intermediate

Subject: Returns on Small Stocks

Type: Essays

139. What are the lessons learned from capital market history? What evidence is there to suggest these lessons are correct? Ans: First, there is a reward for bearing risk, and second, the greater the reward, the greater the risk. As evidence, the students should provide a brief discussion of the historical rates of return and standard deviation of returns of the various asset classes discussed in the text. Level: Intermediate

Subject: Lessons

Type: Essays

140. Define the three forms of market efficiency. Ans: The student should present a straightforward discussion of weak (all past prices are in the current price), semi-strong (all public information is in the current price), and strong form (all information is in the current price) market efficiency. Level: Basic

Subject: Efficient Markets

Type: Essays

141. Explain why it is that in an efficient market, investments have an expected NPV of zero. Ans: In an efficient market, prices are "fair" so that the cost of an investment is neither too high nor too low. Thus, on average, investments in that market will yield a zero NPV. Investors get exactly what they pay for when they buy a security in an efficient market and firms get exactly what their stocks and bonds are worth when they sell them. Level: Intermediate

Subject: Efficient Markets

Type: Essays

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

142. Do you think the lessons from capital market history will hold for each year in the future? That is, as an example, if you buy small stocks will your investment always outperform Treasury bonds? Ans: The student should realize that we are working with averages, so they should not expect riskier assets to always outperform less risky assets. The student should explain somewhere in their answer that this gets to the heart of what risk is. That is, the reason you expect to earn a higher return over the long haul is that your variability in price from year to year can be significant. Level: Intermediate

Subject: Efficient Markets

Type: Essays

143. Suppose your cousin invests in the stock market and doubles her money in a single year while the market, on average, earned a return of only about 15%. Is your cousin's performance a violation of market efficiency? Ans: No, market efficiency does not preclude investors from "beating the market. " It is entirely possible to earn higher returns than the market at times. However, if your cousin is able to do so consistently, then there would certainly be some doubt cast upon market efficiency. Level: Intermediate

Subject: Market Efficiency

Type: Essays

144. How do you think the stock market would be affected if the laws were changed so that trading on insider information was no longer illegal? What would be the impact on the goal of the financial manager if such a change were to occur? Ans: This open-ended question allows students to ponder market efficiency from a different angle. By allowing insiders to trade on their information, it would be possible for insiders to take advantage of uninformed investors. This may keep some investors out of the market because they would perceive the prices observed as no longer being "fair. " This change would provide a serious blow to the efficiency of the market and would also further complicate the issue of who's interest managers are working to satisfy. Level: Challenge

Subject: Insider Trading

Type: Essays

145. Why should a financial decision maker such as a corporate treasurer or CFO be concerned with market efficiency? Ans: Good answers to this question might indicate that market efficiency is a necessary condition for the "Maximize Shareholder Wealth" rule. Unless we are confident that the market price is an economically meaningful number, seeking to maximize it is silly. Similarly, students should recognize that there is a very strong link between managerial decisions and the value of the firm, as reflected in security prices. Finally, as a preview of the cost of capital discussion in later chapters, instructors might point out that market efficiency ensures that the required returns on new securities will be directly related to the risk-return profile of the firm (and, therefore, to managerial actions). Level: Challenge

Subject: Market Efficiency

Type: Essays

146. Retirees with limited income and small investment portfolios are generally perceived as facing a real dilemma when it comes to investment risk and return. Explain this dilemma and what its implications are for the retirees. Ans: This question is designed to help students realize that higher rates of return also represent higher possibilities of investment losses, especially in the short-term. While retirees may need a high return, they cannot afford the short-term risk to their principal and therefore are generally forced to accept lower returns. Level: Intermediate

Subject: Risk And Return

Type: Essays

Copyright © 2005 McGraw-Hill Ryerson Limited.

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Chapter 12 Some Lessons from Capital Market History

147. There is a common saying among investment professionals that "past performance does not guarantee future returns." If this statement is correct, then why is it important to understand the past performance of various asset classes? Ans: Student answers will vary. One general theme might be that history provides a basis for comparison along with a general understanding of the risk-return tradeoff. Historical performance also provides investors with some understanding of what they can reasonably expect to earn. These expectations affect the prices investors are willing to pay, thereby tending to keep the performance of an asset class within its historical averages. Level: Intermediate

Subject: Historical Rates Of Return

Type: Essays

Copyright © 2005 McGraw-Hill Ryerson Limited.

Page 31

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