Ch 12-Lessons from History Flashcards by Unknown Unknown

what are non financial assets?

REAL assets: not stocks and not bonds

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Risk return tradeoff

THHE GREATER THE RISK THE GREATER THE REWARD

Risk: measured in standard deviation
Return: measured in %

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What is total dollar return?

income from investment + capital gain (loss) due to change in price

income from investment: the coupons
capital gain: the change in the actual price of bond

P1-Po + D = dollar return formula

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What is percentage returns

div yield= income/beginning price (D/p)

cap gain yield= (end price- begin price)/begin price

total % return= div yield +cap gain yield

THINKING IN PERCENTAGES IS OFTEN EASIER THAN DOLLARS

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Percent returns on bonds

P1/P0 - 1 + coupon rate

(P0- P1 + D)/ P0 = total percentage return of the bond

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fisher equaiton

(1+R)= (1+r)(1+h)

R= nominal
r= real
h= inflation

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Why do people buy bonds?

Because the standard deviation is generally lower!! meaning that good years arent that good but more importantly BAD YEARS ARE NOT THAT BAD

-> THEY HAVE LOWER STANDARD DEVIATION

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Within one standard deviaiton, how much area is covered?
Within2?
Within 3?

2/3
19/20
Most

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How to find SD in calculator

List all the returns in the column
Stat > Calc > 1-Var Stats
List: L1 FreqList: EMPTY Caclaulte

xbar= v

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Why should you leave FreqList blank?

Because it is asking how often you should use the list

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What is the arithmetic avg
Geometric avg?

-50 and 50, avg is 0

geometric [(1+return)(1+return2)]^1/2 -1

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When Is the geometric average a lot different from you rarithmetic average

when you have a really bad year !!! when you have a really good year

IF THE YEARS ARE RELATIVELY CHILL THEN YOUR ARITHMETIC AVERAGE IS ABOUT THE SMAE AS THE GEOMETRIC AVERAGE

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TWO LESSONS FROM HISTORY

1) there is a reward for bearing risk
2) the greater the risk the greater the reward

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What are the two components of return

give an ex

1) income: any cash you recieve while you own the invetment
2) capital gain/loss: any change in value of the asset while you own it

ex: if you hold a stock, you may recieive dividend, and if you wanna sell it the price may have changed (this is cap gain/loss)

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Formula for total dollar return

TDR= Div income + Cap Gain/Loss

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If you sold stock at the end of the year, what is the total amt of cash you owuld have?

Total cash if stock is sold= initial investment + total return

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What are percentage returns

Percentage return = (div paid at end of period + change in market value over period)/ begin market value

1+ % return = (Div ppaid at end of period + MV at end of period)/begin MV

DIV YIELD + CAP GAINS YIELD

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wHAT IS FIVIDEND YIELD

tells you how much you get in dividends for each dollar you invest

Div Yield= Dt/Pt

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What is cap gains yield

Cap gains yield = (Pt+1 - Pt)/Pt

Pt= current price of stok

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WHAT ARE THE 6 TYPES OF PORTFOLIOS?

canadian common stocks
usa common stocks
tsx venture stocks
small stocks
long bonds
canada treasury bills

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if stocks perform the best as investments, why would people invest in others like tbilss and long term bonds?

they grow steadily even though they grow sloly

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how do you calculate expected return

arithmetic average

sum of n/n

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are averages taken over short periods of time reliable?

not at all!

what is a risk premium

reard for bearing risk, you get this as additional return when you move from owning risk free things like t-billst orisky things like stocks

calculation (stock return - tibill return= risk premium)

what is the variance of a return?

average squared differemce between actual returns and aveg return biggeeer= more variance

what are the measures of volatiltiy

variance and standard deviaton

variance formula

T= histotrical returns Var(R) = [(R1-R)^2 + ... (Rt-R)^2]/T-1 Take each individiual return, subtra t the average return (R), square the result, add them ,divide by t-1

standard deviation is what?

sqrt(var)

why is normal distribution important

- completely descirbed by average (centre/mean) and standard deviation (jumps out from the mean) - prob of being within 1 sd is66%, 2 sd's is 95%, prob of being more than 3 sds away is <1% - tells us that if you buy stocks in larger compannies there is 1/3 chance you are outside this range

what is the value at risks

the amount of money that is at risk with your actions; it is a measure of possible loss

what does growth stock mean?

small company stock

Looking back at Table 12.4, the average return on small stocks is 12.04% and the standard deviation is 25.49%. Assuming the returns are approximately normal, there is about a one-third probability that you could experience a return outside the range −13.45% to 37.53% (12.04 plus or minus one standard deviation). Because the normal distribution is symmetric, the odds of being above or below this range are equal. There is thus a one-sixth chance (half of one-third) that you could lose more than 13.45%. So you should expect this to happen once in every six years, on average. Such investments can therefore be very volatile, and they are not well suited for those who cannot afford the risk.

if an investment is negative 1/6 of the time?

1 in 6 years will be a bad year

what is the geometric average return? - what question does it answer?

what was your average compound return per year over a particular period

what questions does arithmetic average return answerr

what was your return in an average yera of a particular period

how to calc geometric avg returns

[(1+ R1) x (1+R2) x ... (1+Rt)]^1/T -1 - take each of the T annual returns and add a one to each (After they are in decimalls) - multiple all numbers from the first step together - take the product to the power of 1/T - subtract 1 MISSING RETURNS? (P1- P0 +D)/P0

is geometric avg return bigger or smaller than arithmetic?

smaller slways!!! (As long as returns are not idenitcla) generally it is arithmetic- half the variance

when should you use arithmetic avg and when geometric avg

FOR LOOKING AT PAST: geometric = tells you what you actually earned per year on avg comp annually arithmetic= what you earned in a typicla year FOR LOOKING AT FUTURE: Long run= use arithmetic (optimistic as they are higher) SHort run= use geometric (pessimistic) If you know the arithmetic accg for sure then use that one!!

why doo prices of stocks and bonds fluctuate?

becausse new info arrives and and investors reassess their asset values based on info

what is an effeciivent capital market

when current prices fully refelect available info (reacts quickly ot ingo)

in the visual, what is an efficient market reaction

straight lines

in the visual what is a delayed reaction,

line going under

in the visual what is overreaction and ocrrecion

line going over@

what is efficient markets hypothesis

well orgnaized cap markets such as the TSX and NYSE are efficient (prractically) when markets are efficient, all investmetns are zero NPV investmetns (if prices are just right then the diff between market val of investment and cost is 0)YOU GET EXACTLY WHAT YOU PAY FOR WHEN YOU BUY SECURITITES

SOME MARKETS ARE MORE EFIFICENT THAN OTHERS

FINANCIAL MARKETS AS A WHOLE ARE MORE EFFICIENT THEN REAL ASSET MARKETS

3 types of market effiicnecy

1. weak form efficient: (reflection of old stock prices) 2. semistrong form efficient: (only public info reflected in stocks price, no matter what publicly available information mutual fund managers rely on to pick stocks, their average returns should be the same as those of the average investor in the market as a whole) 3. strong form eficient: all info of all kind is reflected in stocks (no isnider nfo)

if mispriced stocks do exist, there is no obvious means of identifying them

purr

how to calc arithmetic avg returns?

1. get every years return (P1-P0+D)/P0 2. get average of it

WHEN YOU GET STANDARD DEVIATION!!! DO YOU CARE ABOUT Sx or SIGMAx

ALWAYS Sx

treasury bills are considered to be

risk free

the risk premium is the return over and above the risk free rate

EFFICIENT MARKETS DOOO NOTTTTTTTTTTT IMPLY THAT INVESTORS CANT EARN A POSTIIVE RETURN

JUST THAT THEY SHOULD NOT BE ABLE TO EARN ABNORMALLY HIGH RETURNS

whAT Makes a market efficient

investorys doing research and analysts doing research and then adjusting the prices throhg buying and selling

They do mean that, on average, you will earn a return that is appropriate for the risk undertaken and there is not a bias in prices that can be exploited to earn excess returns`

market efficiency will not protect you from wrong choices if you do not diversify - you still don’t want to put all your eggs in one basket. 12.6 Capital Market Efficiency