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Finance—Final Study Guide
Chapter 10
Dollar Returns
: if you buy any asset, your gain or loss from that investment is called your return on
investment and usually has 2 components—1) you may receive cash directly while you own investment
(income component) 2) value of your asset you purchase will often change—capital gain or loss
Total Dollar Return= Div. Inc. + Capital Gain (Loss)
Percentage Returns
: How much do we get for each dollar we invest? DIVIDEND YIELD= D/P where D is
the dividend paid on the stock during year and P is stock price at beginning of year; Second component is
CAPITAL GAIN YIELD= (P
1
P
0
)/ P
0
which is the change in price during year divided by beginning price;
putting it together we get X in dividends and X in capital gains yield and our final % return is both added
together
Average Returns
: See Notes and PAGE 297—TBills, Gov. Bonds, Corp. Bonds, Lg./Sm. Stocks
Risk Premiums
: excess return req’d from an investment in a risky asset over that req’d from a riskfree
investment—TBills are RISKFREE b/c gov. can always raise taxes to pay bills
Frequency Distributions and Variability
: we need a measure of how volatile a return is, two common
measures of volatility are:
Variance: avg. squared difference between actual and average return—bigger the number, more
actual returns differ from average returns and more spread out returns will be
Standard Deviation: positive square root of variance
Normal Distribution
: symmetric, bellshaped curve that is completely defined by its variance and standard
dev. SEE FIGURE 1010 PG 307
Geometric Average Return
: average compound return earned per year over a multiyear period
GAR= [(1+R
1
) x (1+ R
2
) x … (1+R
100
)]
1/T
– 1 where R is return; will always be equal to or less than
arithmetic average
Average Arithmetic Return
: return earned in an avg. year over a multiyear period; simply just adding all
returns up and dividing by number of years
Geometric VS. Average
: to forecast up to a decade use AAR, if a few decades split difference between
AAR and GAR, if long forecasts using many decades use GAR
Efficient Capital Market
: market in which security prices reflect available info—basically saying there is
no reason to believe price is too high or too low
Efficient Market Hypothesis (EMH):
hypothesis that actual capital markets, such as the NYSE, are
efficient; New info rapidly incorporated into price; Hard to “beat” markets by selection and timing; “buy
and hold” strategy may be best
Chapter 11
Expected Return
: return on a risky investment expected in the future; If you have Stock X for a number of
years, you’ll earn 30% half the time and 10% the other half, therefore expected return is 20%E(R)= .5 x
30% + .5 x 10%=20%; Risk Premium= Expected Return Riskfree rate
Portfolio
: group of assets such as stocks and bonds held by an investor
Portfolio Weight
: % of a portfolio’s total value in a particular asset; if we have $50 in one asset and $150
in another, then our total portfolio weight is $200, the % of our portfolio in our first asset is $50/200=25%
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 Spring '08
 Nelson

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