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# 2504c_1115 - BUSI 2504c Essentials of Business Finance...

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BUSI 2504c - Essentials of Business Finance Monday, November 15, 2010 §12 capital market history §13 risk and return: portfolios 3 rd hour (optional) midterm solutions

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chapter 12: capital market history §12.1 - Returns §12.2 - The Historical Record §12.4 - Average Returns: The First Lesson §12.5 - The Variability of Returns: The Second Lesson §12.6 - More on Average Returns §12.7 - Capital Market Efficiency BUSI 2504c Monday, November 15, 2010 2 / 62
chapter 12: 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 Risk-Return Trade-Off - The greater the potential reward, the greater the risk BUSI 2504c Monday, November 15, 2010 3 / 62

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12.1: dollar returns - formulas dollar returns [bonds and stocks] Total Dollar Return = Income from Investment + Capital Gain/Loss due to Change in Price = Coupon Payments + End Price - Start Price [ bonds ] = ( Dividends ) + End Price - Start Price [ stocks ] BUSI 2504c Monday, November 15, 2010 4 / 62
12.1: dollar returns (figure 12.1, p.342) Inflows Outflows \$4,218 \$185 \$4,033 Time Initial investment Ending market value TOTAL Dividends 0 1 \$3,700 BUSI 2504c Monday, November 15, 2010 5 / 62

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12.1: dollar returns - example You bought a bond for \$950 one year ago. You have received two coupons of \$30 each. You can sell the bond for \$975 today. What is your total dollar return? answer : \$85 BUSI 2504c Monday, November 15, 2010 6 / 62
12.1: percentage returns It is generally more intuitive to think in terms of percentages than dollar returns Dividend Yield = Income Start Price Capital Gains Yield = (End Price) - (Start Price) Start Price Total Percentage Return = Dividend Yield + Capital Gains Yield BUSI 2504c Monday, November 15, 2010 7 / 62

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12.1: percentage returns (figure 12.2, p.343) Inflows Outflows \$42.18 \$1.85 \$40.33 Time Ending market value TOTAL Dividends t t + 1 \$37 Percentage return = 1 + Percentage return = Dividends paid at end of period Dividends paid at end of period Change in market value over period Market value at end of period Beginning market value Beginning market value + + BUSI 2504c Monday, November 15, 2010 8 / 62
12.1: dollar and percentage returns - example 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 % BUSI 2504c Monday, November 15, 2010 9 / 62

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12.1: cash flow (figure 12.3, p.344) Cash inflows Cash outflows \$37 \$2 \$35 Time Ending price per share ( P 1 ) TOTAL Dividends (Div 1 ) 0 1 \$25 ( P 0 ) BUSI 2504c Monday, November 15, 2010 10 / 62
12.2: the importance of financial markets Financial markets allow companies, governments and individuals to increase their utility Savers have the ability to invest in financial assets so that they can defer consumption and earn a return to compensate them for doing so Borrowers have better access to the capital that is available so that they can invest in productive assets

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