chapter 10

Question 1

two key lessons from capital market history

Answer 1

1. there is a reward for bearing risk
2. the greater the reward, the greater the risk

Question 2

total dollar return

Answer 2

return on an investment measured in dollars

Question 3

dollar return =

Answer 3

dividends + capital gains

Question 4

capital gains =

Answer 4

price received - price paid

Question 5

total percent return

Answer 5

return on an investment measured as a percentage of the original investment

Question 6

percent return =

Answer 6

dollar return / dollar invested

Question 7

historical average return

Answer 7

arithmetic, or simple, average

Question 8

risk-free rate

Answer 8

rate of return on a riskless investment (treasury bills)

Question 9

risk premium

Answer 9

excess return on a risky asset over risk-free rate
- the reward for bearing risk

Question 10

variance

Answer 10

common measure of return dispersion (variability)

Question 11

standard deviation

Answer 11

square root of variance (volatility)

Question 12

which stocks have the highest historical average standard deviation and mean?

Answer 12

small company stocks

Question 13

efficient capital market

Answer 13

market in which security prices reflect available information

Question 14

efficient markets hypothesis

Answer 14

the hypothesis that actual capital markets, such as the NY stock exchange, are efficient
- stock prices are in equilibrium
- stocks are fairly priced
- informational efficiency

Question 15

important implication for efficient market

Answer 15

all investments are zero NPV investments

Question 16

efficient markets do not imply that

Answer 16

investors cannot earn a positive return in the stock market

Question 17

what makes a market efficient

Answer 17

competition among investors

Question 18

forms of market efficiency

Answer 18

strong form efficient market
semistrong form efficient market
weak form efficient market

Question 19

strong form efficient market

Answer 19

all information of every kind is reflected in stock prices, no such thing as inside information

Question 20

semistrong efficient market

Answer 20

all public info is reflected in stock price, fundamental analysis is of little use

Question 21

most controversial market

Answer 21

semistrong, implies that security analysts who try to identify mispriced stocks are wasting their time

Question 22

weak form efficient market

Answer 22

current stock price reflects its own past prices, technical analysis (searching for patterns) is of little use

Question 23

according to strong form efficiency, investors cannot

Answer 23

earn abnormal returns regardless of the info they possess

Question 24

empirical evidence indicates that

Answer 24

markets are generally weak form efficient and not strong form efficient

Question 25

EMH does mean that

Answer 25

- on average, you will earn an appropriate return for the risk undertaken - there is no bias in prices that can be exploited to earn excess returns