ESSENTIAL_LECTURE_CAPM[1]Updated

If the risk-free rate is 6.15%, what is the risk premium? Stock C: 9.9% – 6.15% = 3.75% Stock T: 17.7% – 6.15% = 11.55%

There is a reward for bearing risk We call this reward a Risk Premium Risk Premium is larger for riskier investments


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

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.


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%
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

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%

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.
As part of its quality assurance program, the Autolite Battery Company conducts tests on battery life. For a particular D-cell alkaline battery, the mean life is 19 hours. The useful life of the battery follows a normal distribution with a standard deviation of 1.2 hours. Answer the following questions. 1. About 68 percent of the batteries failed between what two values? 2. About 95 percent of the batteries failed between what two values? 3. Virtually all of the batteries failed between what two values?he 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%.

$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?

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




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