Lecture 9 Ch 10 UGBA 103 2011

Lecture 9 Ch 10 UGBA 103 2011 - Chapter 10 Capital Markets...

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Chapter 10 Capital Markets and the Pricing of Risk
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10- Highlights of Last Lecture Return: Dividend-discount model: Discounted Free Cash Flows Enterprise value = PV(Future Free Cash Flow of Firm) Enterprise value = Equity + Debt - Cash
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10- QUIZ QUIZ QUIZ QUIZ QUIZ
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10- Figure 10.1 Value of $100 Invested at the End of 1925 in U.S. Large Stocks (S&P 500), Small Stocks, World Stocks, Corporate Bonds, and Treasury Bills
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10-
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10- Nikkei 225 Index
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7 Percentage Returns Discount rates are usually specified in percentage terms, i.e., in terms of per $ invested. Some Definitions: Percentage Return = Dividend Yield + Capital Gain
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Return calculations--when all dividends are reinvested (Arithmetic) Average Return Geometric Average Return Holding period Return 8 R = R i i = 1 N N R GeometricAve = 1 + R i ( ) i = 1 N 1/ N 1 R HoldingPeriod = 1 + R i ( ) i = 1 N 1
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NOT A QUIZ Are arithmetic average stock returns or geometric average stock returns usually higher? A) arithmetic average B) geometric average 9
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10- Arithmetic average returns versus geometric average and holding period returns Suppose you buy a stock for $10. At the end of year 1, it has paid no dividends and is trading at $15. What is your return for year one? At the end of year two, the stock has paid no dividends and is trading at $10. What is your return for year two? R 1 = 15 10 10 = 0.5 = 50% R 2 = 10 15 15 = 0.333 = -33.3%
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10- Arithmetic average returns versus geometric average and holding period returns (cont) What is your (arithmetic) average return? What is your geometric average return? Holding period return? R = 0.5 0.33 2 = 0.0833 = 8.33% R geometricAve = 1 + 0.5 ( ) 1 0.33 3 ( ) ( ) 1/2 1 = 0 R HoldingPeriod = 1 + 0.5 ( ) 1 0.33 3 ( ) 1 = 0
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10- 12 Variance One measure (but not the only measure) of the variation in returns. Definition: Variance estimate using realized returns: where Var ( R ) = E R E R ( ) ( ) 2 ( ) Var ( R ) = 1 T 1 R t R ( ) t = 1 T 2 R = 1 T R t t = 1 T
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