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chap011-1

# chap011-1 - Solutions to Chapter 11 Introduction to Risk...

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Solutions to Chapter 11 Introduction to Risk, Return, and the Opportunity Cost of Capital 1. Dividend yield = dividend/initial share price = \$2/\$40 = 0.05 = 5% Capital gains yield = capital gain/initial share price = \$4/\$40 = 0.10 = 10% 2. Dividend yield = \$2/\$40 = 0.05 = 5% The dividend yield is unaffected; it is based on the initial price, not the final price. Capital gain = \$36 – \$40 = - \$4 Capital gains yield = –\$4/\$40 = –0.10 = –10% 3. a. b. c. 11-(

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4. Costaguana: Real return U.S.: Real return The U.S. provides the higher real rate of return despite the lower nominal rate of return. Notice that the approximate relationship between real and nominal rates of return is valid only for low rates: real rate of return nominal rate of return – inflation rate This approximation incorrectly suggests that the Costaguanan real rate was higher than the U.S. real rate. 5. We use the following relationship: Asset class Nominal rate Inflation rate Real rate Treasury bills 4.0% 3.0% 0.97% Treasury bonds 5.3% 3.0% 2.23% Common stocks 11.6% 3.0% 8.35% 6. The nominal interest rate cannot be negative. If it were, investors would choose to hold cash (which pays a rate of return equal to zero) rather than buy a Treasury bill providing a negative return. On the other hand, the real expected rate of return is negative if the inflation rate exceeds the nominal return. 7. Quarter Average price of stocks in market Index (using DJIA method) Total market value of stocks Index (using S&P method) 1 875.83 100 663,736 100 2 857.50 97.91 654,456 98.60 3 906.67 103.52 691,336 104.16 11-(
4 911.67 104.09 685,256 103.24 11-(

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8. a. For the period 1900-2007, Average rate of return = 11.6% (See Table 11-1) b. For the period 1900-2007, Average risk premium = 7.6% (See Table 11-1) c. For the period 1900-2007, Standard deviation of returns = 19.7%. (See Table 11-5) 9. a. Year Stock market return T-bill return Risk premiu m Deviation from mean Squared deviation 2003 31.64 1.02 30.62 19.146 366.57 2004 12.62 1.2 11.42 -0.054 0.00 2005 6.38 2.98 3.4 -8.074 65.19 2006 15.77 4.8 10.97 -0.504 0.25 2007 5.62 4.66 0.96 -10.514 110.54 Average 11.474 542.56 b. The average risk premium was: 11.474% c. The variance (the average squared deviation from the mean) was 409.2538 (without correcting for the lost degree of freedom). Therefore: standard deviation = 10. In 2007, the Dow was substantially more than four times its 1990 level. Therefore, in 2007, a 40-point movement was far less significant in percentage terms than it was in 1990.
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