Ch 12-Lessons from History Flashcards
what are non financial assets?
REAL assets: not stocks and not bonds
Risk return tradeoff
THHE GREATER THE RISK THE GREATER THE REWARD
Risk: measured in standard deviation
Return: measured in %
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
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
Percent returns on bonds
P1/P0 - 1 + coupon rate
or
(P0- P1 + D)/ P0 = total percentage return of the bond
fisher equaiton
(1+R)= (1+r)(1+h)
R= nominal
r= real
h= inflation
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
Within one standard deviaiton, how much area is covered?
Within2?
Within 3?
2/3
19/20
Most
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
Why should you leave FreqList blank?
Because it is asking how often you should use the list
What is the arithmetic avg
Geometric avg?
-50 and 50, avg is 0
geometric [(1+return)(1+return2)]^1/2 -1
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
TWO LESSONS FROM HISTORY
1) there is a reward for bearing risk
2) the greater the risk the greater the reward
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)
Formula for total dollar return
TDR= Div income + Cap Gain/Loss
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
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
OR
DIV YIELD + CAP GAINS YIELD
wHAT IS FIVIDEND YIELD
tells you how much you get in dividends for each dollar you invest
Div Yield= Dt/Pt
What is cap gains yield
Cap gains yield = (Pt+1 - Pt)/Pt
Pt= current price of stok
WHAT ARE THE 6 TYPES OF PORTFOLIOS?
- canadian common stocks
- usa common stocks
- tsx venture stocks
- small stocks
- long bonds
- canada treasury bills
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
how do you calculate expected return
arithmetic average
sum of n/n
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.
1
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
- weak form efficient: (reflection of old stock prices)
- 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) - 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?
- get every years return
(P1-P0+D)/P0 - 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
