Chapter 12 Some Lessons from Capital Market History 0
0 Chapter 12 Some Lessons from Capital Market History
Chapter Outline ■Returns The Historical Record Average Returns:The First Lesson The Variability of Returns:The Second Lesson More on Average Returns Capital Market Efficiency
1 Chapter Outline n Returns n The Historical Record n Average Returns: The First Lesson n The Variability of Returns: The Second Lesson n More on Average Returns n Capital Market Efficiency
Key Concepts and Skills Know how to calculate the return on an investment Understand the historical returns on various types of investments Understand the historical risks on various types of investments
2 Key Concepts and Skills n Know how to calculate the return on an investment n Understand the historical returns on various types of investments n Understand the historical risks on various types of investments
Risk,Return,and Financial Markets We can examine returns in the financial markets to help us determine the appropriate returns on non-financial assets Lessons from capital market history There is a reward for bearing risk The greater the risk,the greater the potential reward oThis is called the risk-return trade-off
3 Risk, Return, and Financial Markets n We can examine returns in the financial markets to help us determine the appropriate returns on non-financial assets n Lessons from capital market history q There is a reward for bearing risk q The greater the risk, the greater the potential reward q This is called the risk-return trade-off
Dollar Returns Total dollar return income from investment capital gain (loss)due to change in price 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? ■Income=$30+$30=$60 Capital gain $975-$950 $25 Total dollar return $60 $25 $85
4 Dollar Returns n Total dollar return = income from investment + capital gain (loss) due to change in price n Example: q 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? n Income = $30 + $30 = $60 n Capital gain = $975 – $950 = $25 n Total dollar return = $60 + $25 = $85
Percentage Returns It is generally more intuitive to think in terms of percentages than dollar returns Dividend yield income beginning price Capital gains yield =(ending price- beginning price)/beginning price Total percentage return dividend yield capital gains yield 5
5 Percentage Returns n It is generally more intuitive to think in terms of percentages than dollar returns n Dividend yield = income / beginning price n Capital gains yield = (ending price – beginning price) / beginning price n Total percentage return = dividend yield + capital gains yield
Example:Calculating Returns 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% 6
6 Example: Calculating Returns n You bought a stock for $35 and you received dividends of $1.25. The stock is now selling for $40. q What is your dollar return? n Dollar return = 1.25 + (40 – 35) = $6.25 q What is your percentage return? n Dividend yield = 1.25 / 35 = 3.57% n Capital gains yield = (40 – 35) / 35 = 14.29% n Total percentage return = 3.57 + 14.29 = 17.86%
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 they can defer consumption and earn a return to compensate them for doing so Borrowers have better access to the capital that is available,allowing them to invest in productive assets Financial markets also provide us with information about the returns that are required for various levels of risk
7 The Importance of Financial Markets n Financial markets allow companies, governments, and individuals to increase their utility q Savers have the ability to invest in financial assets so they can defer consumption and earn a return to compensate them for doing so q Borrowers have better access to the capital that is available, allowing them to invest in productive assets n Financial markets also provide us with information about the returns that are required for various levels of risk
FIGURE 10.4 A $1 investment in different types of portfolios:1925-2006(Year-end 1925 S1) $20,000 S15,922.43 $10.000 S3.077.33 Small-company stocks s1,000 Large-company stocks $100 $71.69 Long-term $19.29 government bonds $11.26 $10 Inflation Treasury bills $0LLLLLLLLLLLLLLLLLLLLLLL山 1925 1935 1945 1955 1965 1975 1985 1995 2006 Year-end 8 Slide 10.8 Source:Stocks,Bonds,Bills,and Inflation YearbookTM,lbbotson Associates,Inc.,Chicago (annually updates work by Roger G.Ibbotson and Rex Sinquefield).All rights reserved
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Year-to-Year Total Returns Large-Company Stock Returns Large Companies Long-Term Government Bond Returns Long-Term Government Bonds U.S.Treasury Bill Returns U.S.Treasury Bills 9
9 Year-to-Year Total Returns Large-Company Stock Returns Long-Term Government Bond Returns U.S. Treasury Bill Returns
