week 12 Flashcards
what are the three levels of return
required return
expected return
realised return
what is required return
before you buy
what an investor can earn on similar risk assets
what is expected return
if you buy
what an investor can expect to earn by buying the asset under certain assumptions
what is realised return
after you sell
what an investor actually earned by buying and selling the asset
how do you calculate total pound return
income from investment + capital gain/loss due to change in price
how do you calculate realised return
rt = Dt / Pt-1 + (Pt - Pt-1) / Pt-1
how do you calculate dividend yield
DY = D1 / P0 or Dt / Pt-1
how do you calculate capital gains yield
(ending price - beginning price) / beginning price
(Pt - Pt-1) / Pt-1
how do you calculate total return (%)
dividend yield + capital gains yield
how do you calculate average arithmetic returns
add all the percentages and divide by total number of percentages
what are risk premiums
extra return earned for taking on a risk
the return over and above the risk free rate
what is risk
measured by the dispersion, spread or volatility of returns
the greater the volatility, the greater the uncertainty
what is the arithmetic average return
return earned in an average period over multiple periods
what is geometric average return
average compound return per period over multiple periods
how do you calculate geometric return
πΊπ΄π =[(1+π 1 )Γ(1+π 2 )Γβ¦Γ(1+π π )]^(1βπ)β1
is arithmetic or geometric return better
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
how do market prices respond to news
financial prices respond to changing views about future
markets look forward to predict prices
stock prices embody changing views about future prospects of companies
what are efficient capital markets
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
what is an efficient market reaction
price instantly adjusts and fully reflects new info
no need for subsequent increases/decreases to occur
what is a delayed reaction
price partially adjusts to new info, time elapses before price completely reflects new info
what is overreaction
price over adjusts to new info, overshoots and subsequently corrects
what makes markets efficient
many investors conduct new research, new info comes to market and trades are made based on this
prices should reflect all available info
what is weak form efficiency
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
what is semi-strong efficiency
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
what is strong form efficiency
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
what are common misconceptions about EMH
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
