Chap012s - Some Lessons From Capital Market History Chapter...

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Some Lessons From Capital Market History Chapter Twelve
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Risk, Return and Financial Markets We can examine returns in the financial markets to help us determine the appropriate returns on non-financial assets Lesson from capital market history There is a reward for bearing risk The greater the potential reward, the greater the risk This is called the risk-return trade-off
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Dollar Returns Total dollar return = income from investment + capital gain (loss) due to change in price Example: You bought a bond for $950 1 year ago. You have received two coupons of $30 each. You can sell the bond for $975 today. What is your total dollar return? Income = 30 + 30 = 60 Capital gain = 975 – 950 = 25 Total dollar return = 60 + 25 = $85
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Percentage Returns It is generally more intuitive to think in terms of percentages than dollar returns Dividend yield = income / beginning price Capital gains yield = (ending price – beginning price) / beginning price Total percentage return = dividend yield + capital gains yield
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Example – Calculating Returns You bought a stock for $35 and you received dividends of $1.25. The stock is now selling for $40. What is your dollar return? Dollar return = 1.25 + (40 – 35) = $6.25 What is your percentage return? Dividend yield = 1.25 / 35 = 3.57% Capital gains yield = (40 – 35) / 35 = 14.29% Total percentage return = 3.57 + 14.29 = 17.86%
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The Importance of Financial Markets
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