Capital Market History

Total Dollar and Percent Returns

  1. Define Total Dollar Return.

    • What is the formula for calculating Dollar Return?

      • Answer: Total dollar return is measured as Dollarreturn=Dividends+CapitalgainsDollar return = Dividends + Capital gains.

      • What is Capital Gains, and how is it calculated?

      • Answer: Capitalgains=Pricereceived−PricepaidCapital gains = Price received - Price paid.

  2. Define Total Percent Return.

    • Write the formula for Total Percent Return.

      • Answer: Percentreturn=Dollarreturn/DollarinvestedPercent return = Dollar return / Dollar invested.

Dividend Yield (DY) and Capital Gains Yield (CGY)

  1. What is Dividend Yield (DY) and how is it calculated?

    • Answer: DY=D<em>t+1P</em>tDY = \frac{D<em>{t+1}}{P</em>t}.

  2. Explain Capital Gains Yield (CGY)

    • What is the formula for CGY?

      • Answer: CGY=P<em>t+1−P</em>tPtCGY = \frac{P<em>{t+1} - P</em>t}{P_t}.

  3. What is the relationship between Percent Return, DY, and CGY?

    • Answer: %Return=DY+CGY\% Return = DY + CGY which can be calculated as %Return=D<em>t+1+P</em>t+1−P<em>tP</em>t\% Return = \frac{D<em>{t+1} + P</em>{t+1} - P<em>t}{P</em>t}.

Example: Calculating Total Returns

  1. Given an investment with a share price of $25, stock price after one year is $35, and dividend paid is $2, calculate:

    • Total dollar return and total percent return.

      • Answers:

        • Total Dollar Return = 2 + (35 - 25) = $12.

        • Percent Return = (1225)=48%(\frac{12}{25}) = 48\%.

U.S. Financial Markets and Average Returns (1926 to 2020)

  1. What are the average returns for different assets?

    • Large stocks: 12.2%

    • Small stocks: 16.2%

    • Long-term corporate bonds: 6.5%

    • Long-term government bonds: 6.1%

    • U.S. Treasury bills: 3.3%

    • Inflation: 2.9%

Risk Premiums

  1. Define the Risk-Free Rate and Risk Premium.

    • What is a risk-free rate considered?

      • Answer: Treasury Bills are considered risk-free.

    • How do you calculate the risk premium for Large Stocks?

      • Answer: Large Stocks Risk Premium = 12.2% - 3.3% = 8.9%.

Return Variability and Statistical Tools

  1. What are Variance and Standard Deviation concerning returns?

    • Define Variance and its formula.

      • Answer: Variance = VAR(R)=∑<em>t=1T(R</em>t−Rˉ)2T−1VAR(R) = \frac{\sum<em>{t=1}^{T} (R</em>t - \bar{R})^2}{T-1}.

    • What is Standard Deviation?

      • Answer: SD(R)=VAR(R)SD(R) = \sqrt{VAR(R)}.

Historical Average Returns and Standard Deviations

  1. Compare the arithmetic mean and geometric mean.

    • How does the geometric mean relate to the arithmetic mean?

      • Answer: Geometric average < Arithmetic average unless all returns are equal.

Efficient Capital Markets

  1. Explain the Efficient Market Hypothesis (EMH).

    • What are the three forms of market efficiency?

      • Strong Form, Semistrong Form, Weak Form.

Common Misconceptions about EMH

  1. What does EMH imply regarding making money and earning returns?

    • Answer: EMH does not mean you cannot make money, but on average, you will earn a return appropriate for the risk taken.