week 12

Question 1

what are the three levels of return

Answer 1

required return
expected return
realised return

Question 2

what is required return

Answer 2

before you buy
what an investor can earn on similar risk assets

Question 3

what is expected return

Answer 3

if you buy
what an investor can expect to earn by buying the asset under certain assumptions

Question 4

what is realised return

Answer 4

after you sell
what an investor actually earned by buying and selling the asset

Question 5

how do you calculate total pound return

Answer 5

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

Question 6

how do you calculate realised return

Answer 6

rt = Dt / Pt-1 + (Pt - Pt-1) / Pt-1

Question 7

how do you calculate dividend yield

Answer 7

DY = D1 / P0 or Dt / Pt-1

Question 8

how do you calculate capital gains yield

Answer 8

(ending price - beginning price) / beginning price
(Pt - Pt-1) / Pt-1

Question 9

how do you calculate total return (%)

Answer 9

dividend yield + capital gains yield

Question 10

how do you calculate average arithmetic returns

Answer 10

add all the percentages and divide by total number of percentages

Question 11

what are risk premiums

Answer 11

extra return earned for taking on a risk
the return over and above the risk free rate

Question 12

what is risk

Answer 12

measured by the dispersion, spread or volatility of returns
the greater the volatility, the greater the uncertainty

Question 13

what is the arithmetic average return

Answer 13

return earned in an average period over multiple periods

Question 14

what is geometric average return

Answer 14

average compound return per period over multiple periods

Question 15

how do you calculate geometric return

Answer 15

𝐺𝐴𝑅=[(1+𝑅1 )×(1+𝑅2 )×…×(1+𝑅𝑁 )]^(1∕𝑇)−1

Question 16

is arithmetic or geometric return better

Answer 16

arithemetic average is overly optimistic for long periods
geometric average is overly pessimistic for short periods
15-20 years use arithmetic
20-40 years do both and find difference
40+ years use geometric

Question 17

how do market prices respond to news

Answer 17

financial prices respond to changing views about future
markets look forward to predict prices
stock prices embody changing views about future prospects of companies

Question 18

what are efficient capital markets

Answer 18

securities are efficient if they incorporate all available information
securities are fairly priced
price changes reflect new info
if true you should not be able to earn excess returns

Question 19

what is an efficient market reaction

Answer 19

price instantly adjusts and fully reflects new info
no need for subsequent increases/decreases to occur

Question 20

what is a delayed reaction

Answer 20

price partially adjusts to new info, time elapses before price completely reflects new info

Question 21

what is overreaction

Answer 21

price over adjusts to new info, overshoots and subsequently corrects

Question 22

what makes markets efficient

Answer 22

many investors conduct new research, new info comes to market and trades are made based on this
prices should reflect all available info

Question 23

what is weak form efficiency

Answer 23

prices reflect all past info such as price and volume
investors cannot earn abnormal returns by trading on market info
implies that technical analysis will not lead to abnormal returns

Question 24

what is semi-strong efficiency

Answer 24

prices reflect all publicly available info
investors cannot earn abnormal returns by trading in public info
implies that fundamental analysis will not lead to abnormal returns

Question 25

what is strong form efficiency

Answer 25

prices reflect all info, including public and private
investors cannot earn abnormal returns regardless of info they possess
empirical evidence indicates that markets are NOT strong form efficient

Question 26

what are common misconceptions about EMH

Answer 26

efficient markets do not imply that investors cannot earn a positive return in the stock market
on average you will earn a return appropriate for risk undertaken
no bias in prices that can be exploited to earn excess returns
market efficiency does not protect you from wrong choices
if you do not diversify