CHAPTER 12
SOME LESSONS FROM CAPITAL
MARKET HISTORY
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require
multiple steps. Due to space and readability constraints, when these intermediate steps are
included in this solutions manual, rounding may appear to have occurred. However, the final
answer for each problem is found without rounding during any step in the problem.
1.
The return of any asset is the increase in price, plus any dividends or cash flows, all divided
by the initial price. The return of this stock is:
R = [($102 – 91) + 2.40] / $91 = .1473 or 14.73%
8.
We will calculate the sum of the returns for each asset and the observed risk premium first.
Doing so, we get:
Year
Large co. stock return
Tbill return
Risk premium
1970
3.94%
6.50%

2.56%
1971
14.30
4.36
9.94
1972
18.99
4.23
14.76
1973
–14.69
7.29
–21.98
1974
–26.47
7.99
–34.46
1975
37.23
5.87
31.36
33.30
36.24
–2.94
a
.
The average return for large company stocks over this period was:
Large company stocks average return = 33.30% / 6 = 5.55%
And the average return for Tbills over this period was:
T
Tbills average return = 36.24% / 6 = 6.04%
U
b
.
Using the equation for variance, we find the variance for large company stocks over this
period was:
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View Full DocumentVariance = 1/5[(.0394 – .0555)
2
+ (.1430 – .0555)
2
+ (.1899 – .0555)
2
+ (–.1469 – .
0555)
2
+
(–.2647 – .0555)
2
+ (.3723 – .0555)
2
]
Variance = 0.053967
And the standard deviation for large company stocks over this period was:
Standard deviation = (0.053967)
1/2
= 0.2323 or 23.23%
Using the equation for variance, we find the variance for Tbills over this period
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 Spring '08
 LAYISH
 Inflation, Corporate Finance, Mean, average return

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