Topic 6

Question 1

Total dollar return =___________ + Capital gain (or loss)

Answer 1

Dividend income

Question 2

Percentage Returns

Percentage return =(Dividends paid at end of period + Change in market value over period) / ________ market value.

Answer 2

Beginning

Question 3

+ Real return is the return after taking out the effects of inflation.

+ Real return shows the percentage change in __________ power.

+ Nominal return is the return before taking out the effects of inflation.

+ Nominal return is the percentage change in the of dollars you have.

Answer 3

buying, number

Question 4

The FIsher Effect

The Fisher effect explores the relationship between real returns (r), nominal returns (R), and _______ (h).

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

The nominal rate is approximately equal to the real rate plus the inflation rate.

                 R ≈ r + h

Answer 4

inflation

Question 5

CAPITAL MARKET HISTORY

+ Risky securities, such as stocks, have had higher average returns than riskless securities, such as Treasury Bills.

+ Stocks of small companies have had higher average returns than those of large companies.

+ Long-term bonds have had higher average yields and returns than ________ bonds.

+ The cost of capital for a company, project, or division can be predicted using data from the markets.

Answer 5

short-term

Question 6

AVERAGE RETURNS: THE FIRST LESSON

+ A way to calculate the average returns on different investments is simply to add up returns for a number of periods and divide by the number of periods (e.g. years, months, days, etc.).

+ The ________ is the excess return required from an investment in a risky asset over a risk-free investment.

+ Lesson from history: ______ assets, on average, earn a risk premium (i.e. there is a reward for bearing risk).

Answer 6

risk premium, Risky

Question 7

VARIABILITY: THE SECOND LESSON

+ The greater the risk, the greater the potential reward.

+ This lesson holds over the________, but may not be valid for the short term.

Answer 7

long term

Question 8

VARIANCE and STANDARD DEVIATION

+ Measures of variability.

+ Variance is the average squared deviation (SUM DIVIDE NUMBER MINUS 1)between the actual return and the average return.

+ Standard deviation is the _______ of the variance.

Answer 8

square root

Question 9

CAPITAL MARKET EFFICIENCY

+ The efficient market hypothesis (EMH) asserts that the price of a security accurately reflects all available information.

+ Implies that all investments have a _______ NPV.

+ Implies also that all securities are fairly priced.

+ If this is true then investors cannot earn ‘abnormal’ or ‘excess’ returns.

Answer 9

zero

Question 10

Efficient market reaction: The price ___________ adjusts to, and fully reflects, new information. There is no tendency for subsequent increases and decreases.

Answer 10

instantaneously

Question 11

Delayed reaction: The price _______ adjusts to the new information. Several days elapse before the price completely reflects the new information.

Answer 11

partially

Question 12

Overreaction: The price over-adjusts to the new information. It ‘overshoots’ the new price, and _________ corrects itself.

Answer 12

subsequently

Question 13

WHAT MAKES MARKETS EFFICIENT ?

+ There are many investors out there doing research:

• As ______ information comes into the market, this information is analysed and trades are made based on this information.
• Therefore, prices should reflect all available public information.

+ If investors stop researching stocks, then the market will not be efficient.

Answer 13

new

Question 14

EMH: COMMON MISCONCEPTIONS

+ __________ do not mean that you can’t make money.

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

+ Market efficiency will not protect you from making the wrong choices if you do not diversify—you still don’t want to put all your eggs in one basket.

Answer 14

Efficient markets

Question 15

Weak-form efficiency: Current prices reflect information contained in the _______ series of prices.

Answer 15

past

Question 16

Semi-strong form efficiency: Current prices reflect information contained in the past series of prices, and all ______ publicly available information.

Answer 16

other

Question 17

Strong-form efficiency: Current prices reflect all available information (e.g. past series of prices, public information and ________ information).

Answer 17

private

Question 18

Risky assets, on average, earn a ________

Answer 18

risk premium

Question 19

The greater the potential _______ from a risky investment, the greater the risk.

Answer 19

reward

Question 20

In an efficient market, prices adjust quickly and correctly to ______ information

Answer 20

new

Question 21

The Efficient Market Hypothesis (EMH) states that well organised capital markets are efficient, and investors ______make abnormal returns

Answer 21

cannot

Question 22

Asset prices in efficient markets are rarely over or under priced, because ‘all available’ information has already been factored into the price, and investors get exactly what they ______.

Answer 22

pay for

Question 23

Capital gain (increase) in ________

Answer 23

share price

Question 24

The greater the risk is, the ______ the required rate of return

Answer 24

greater

Question 25

Following the principle of opportunity cost (the cost of the alternative forgone), at a minimum, the rate of return required on the new project must be ________ than what we get from buy financial assets of similar risk

Answer 25

greater

Question 26

_________ returns: return on investment not adjusted for inflation

Answer 26

Nominal

Question 27

________ returns: returns adjusted for the effects of inflation

Answer 27

Real

Question 28

________: relationship between nominal returns, real returns and inflation

Answer 28

Fisher effect

Question 29

Treasury Bills : the __________ borrows money by issuing bonds

Answer 29

government

Question 30

Risk premium: the _______ return required from an investment in a risky asset over a risk-free investment

Answer 30

excess

Question 31

Variance: the average ________ deviation between the actual return and the average return.

Answer 31

squared

Question 32

Standard deviation: the ________ square root of the variance

Answer 32

positive

Question 33

The greater the _______ reward, the greater the risk.

Answer 33

potential

Question 34

Efficient capital market: market in which security prices reflect all _______ information.

Answer 34

available

Question 35

Efficient market hypothesis (EMH) assert that __________ capital markets such as the Australian Securitites Exchange or the New York stock Exchange are efficient markets, at least as a practical matter. In other words, an advocate of the EMH might argue that while inefficiencies may exits, they are relatively small and not common.

Answer 35

wll-organised

Question 36

All investments in an efficient market are _______ NPV investments.

Answer 36

zero

Question 37

Three forms of market efficiency, depending on the degree of efficiency, we say that markets are either weak form efficien, semi-strong form efficient or strong form efficient. The _______ between these forms relates to what information is reflected in prices.

Answer 37

difference

Question 38

What does capital market history say about market efficiency?

Answer 38

1. Prices do appear to respond very rapidly to new information, and the response is at least not grossly different from what we would expect in an efficient market.
2. The future of market prices, particularly in the short run, is very difficult to predict based on publicly available information.
3. If mispriced shares do exist, then there is no obvious means of identifying them. Put another way, simple-minded schemes based on public information will probably not be successful.