ESSENTIAL_LECTURE_CAPM PART I

i 1
T
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Using the data in Table 10.1:

Your best guess about the size of the return for a year selected at random is 11.7%.
◦ Sum the returns for large-company stocks from 1926 through 2008, you get about 9.71/83 years = 11.7%.


Expected returns are based on the probabilities of possible outcomes In this context, “expected” means average if the process is repeated many times




Large-Company Stock Returns
Long-Term Government Bond Returns
U.S. Treasury Bill Returns
Investment Large Stocks
Small Stocks Long-term Corporate Bonds Long-term Government Bonds U.S. Treasury Bills Inflation

From the previous problem, what was the dividend yield and capital gains yield?

The dividend yield is the dividend divided by price at the beginning of the period



The total dollar return is the change in price plus the coupon payment
A. Total dollar return = ($1056-$1090)+ 80= $ 46 B. Total nominal percentage return of the bond = ($1056-1090) + 80 / $ 1,090 R =4.22% C. Using the Fisher equation, real return= (1+R) = (1+r)(1+h) r= (1.0422/1.030) – 1 r = 1.18%
Table 10.2
Average Return 11.7%
16.4% 6.2% 6.1% 3.8% 3.1%

Historical Average Return = simple, or arithmetic average
His tor ical Ave r age Re turn
ye arlyre turn


Note: The return on any asset is the increase in price, plus any dividends or cash flows, all divided by the initial price.

(($104 -92) + 1.45) / $92 R= 14.62%

A basket of 500 stocks that are considered to be widely held. The S&P 500 index is weighted by market value, and its performance is thought to be representative of the stock market as a whole.


Suppose you have predicted the following returns for stocks C and T in three possible states of nature. What are the expected returns? ◦ State Probability C T ◦ Boom 0.3 15 25 ◦ Normal 0.5 10 20 ◦ Recession 0.2 2 1 RC = .3(15%) + .5(10%) + .2(2%) = 9.9% RT = .3(25%) + .5(20%) + .2(1%) = 17.7%





Dow Jones Industrial Average (The Dow) Price weighted index Closed at 11,189 on 11/2/10
Standard & Poor’s Composite Index (The S&P 500)


Value of a portfolio holding shares in 500 firms. Holdings are proportional to tket Capitalization index)

For example, assume that an index contains only two stocks, one priced at $1 and one priced at $10. The $10 stock is weighted nine times higher than the $1 stock. Overall, this means that this index is composed of 90% of the $10 stocks and 10% of $1 stock. In this case, a change in the value of the $1 stock will not affect the index's value by a large amount, because it makes up such a small percentage of the index.

Suppose a stock had an initial price of $92 per share, paid a dividend of $1.45 per share during the year, and had an ending share of $104. Compute the percentage total return.
USC Dr. Bemis

Know how to calculate expected returns Understand the impact of diversification Understand the systematic risk principle Understand the risk-return trade-off Be able to use the Capital Asset Pricing Model

$1.45/$92 = 1.58%

The capital gains yield is the increase in price divided by the initial price

Capital gains yield = $104-$92/$92= 13.04%

Suppose you bought a 8 percent coupon bond one year ago for $1090. The bond sells for $1056 today. A. Assuming a $1,000 face value, what was your total dollar return on this investment over the past year? B. What was your total nominal rate of return on this investment over the past year? C. If the inflation rate last year was 3 percent, what was your total real rate of return on this investment?

The average is named after Dow and one of his business associates, a statistician, Edward Jones. It is an index that shows how certain large, publicly-owned companies have traded during a standard trading session in the stock market. The performance of the Dow continues to be influenced by not only corporate and economic reports, but also by domestic and foreign political events such as war and terrorism, as well as by natural disasters. The average is computed by the stock prices of 30 of the largest and most widely held public companies in the United States. It is among the most closely-watched benchmark indices tracking targeted stock market activity.