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Finance Notes - Finance Notes Chapter 10 Lessons from...

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March 31, 2008 Finance Notes Chapter 10: Lessons from Capital Market history RETURNS Dollar Returns Dollar Return = Dividend income + capital gain/loss Example: Jan 3, 2007: Buy 100 shares of Ball @ $43.67 Feb 27, 2007: Receive $.10/share dividend March 30, 2007: Sell 100 shares @ $45.48 = .10 + (45.48 – 43.67) = .10 + 1.81 = 1.91 X 100 = $191 (Total) Percent Returns = (Div1/Po) + g; g = (Pi – Po)/Po Holding Period Return (1+PR) = (.10/43.67) + (45.48 – 43.67)/43.67 =.0023 + .0414 =.0437 or 4.4% Annual Percent Return 4.4% X 4 = 17.6% Effective Annual Return N = 4 I = 4.4 PV = -1 PMT = 0 FV = X – 1 1.118 – 1 = .188; 18.8% EAR = (1 + APR/m)^M – 1 = (1 + .176/4)^4 – 1 = (1.044)^4 – 1 = 1.188 – 1 = .188 = 18.8% Growth of $1 1926 – 2004 Inflation = 11 T-Bills = 18
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Government Bonds = 66 Large Stock = 2,533 Small Stock = 12,968 Returns, Risk Premiums, Real returns 1924 – 2004 Investment Average Return % Risk Premium Real Returns Inflation 3.1 n/a n/a T-Bills 3.8 0 .68% Government Bonds 5.8 2 2.6% Corporate Bonds 6.2 2.4 3% Large Stock 12.4 8.6 9% Small Stock 17.5 13.7 14% Risk Premium = A – T Bills (Gov Bonds: 5.8 – 3.8) Real Returns = EST. A – Inflation Exact = ([1 + Avg. Return] / [1 + Inflation]) – 1 Variability of Returns Risk measured as standard deviation
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