Questions On Financial Finance

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MANAGERIAL FINANCE –BUS503

Professor : Rob Shah, MBA, CPA, CMA

Course Dates : 01/12 – 03/08

Name : NAVEEN XAVIER

Know how to calculate the return on an investment
Know how to calculate the standard deviation of an investment’s returns
Understand the historical returns and risks on various types of investments
Understand the importance of the normal distribution Understand the difference between arithmetic and geometric average returns

Dollar Return = Dividend + Change in Market Value Returns
Example  Suppose you bought 100 shares of XYZ Co. one year ago today at $45. Over the last year, you received $27 in dividends (27 cents per share 100 shares). At the end of the year, the stock sells for $48. How did you do? You invested $45 100 = $4,500. At the end of the year, you have stock worth $4,800 and cash dividends of $27. Your dollar gain was $327 = $27 + ($4,800 – $4,500).
Your percentage gain for the year is: 7.3% = $4,500 $32710-6 Returns: Example Dollar Return: $327 gain Time 0 1 -$4,500 $300

Holding Period Return  The holding period return is the return that an investor would get when holding an investment over a period of T years, when the return during year i is given as Ri : (1+R1) *(1+R2 )*…(1+RT) -1
Historical Returns A famous set of studies dealing with rates of returns on common stocks, bonds, and Treasury bills was conducted by Roger Ibbotson and Rex Sinquefield.
They present year-by-year historical rates of return starting in 1926 for the following five important types of financial instruments in the United States:
Large-company Common Stocks Small-company Common Stocks
Long-term Corporate Bonds Long-term U.S. Government Bonds
U.S. Treasury Bills10-10 10.3 Return Statistics
Average Stock Returns and Risk-Free Returns The Risk Premium is the added return (over and above the risk-free rate) resulting from bearing risk. One of the most significant observations of stock market data is the long-run excess of stock return over the riskfree return.
The average excess return from large company common stocks for the period 1926 through 2011 was: 8.2% = 11.8% – 3.6%
The average excess return from small company common stocks for the period 1926 through 2011 was: 12.9% = 16.5% – 3.6%
The average excess return from long-term corporate bonds for the period 1926 through 2011 was: 2.8% = 6.4% – 3.6%10-13
Risk Premiums Suppose that The Wall Street Journal announced that the current rate for one-year Treasury bills is 2%. What is the expected return on the market of smallcompany stocks?
Recall that the average excess return on small company common stocks for the period 1926 through 2011 was 12.9%.
Given a risk-free rate of 2%, we have an expected return on the market of small-company stocks of 14.9% = 12.9% + 2%
Risk Statistics
There is no universally agreed-upon definition of risk.
The measures of risk that we discuss are variance and standard deviation.
The standard deviation is the standard statistical measure of the spread of a sample, and it will be the measure we use most of this time.
Its interpretation is facilitated by a discussion of the normal distribution.
Normal Distribution
The 20.3% standard deviation we found for large stock returns from 1926 through 2011 can now be interpreted in the following way:
If stock returns are approximately normally distributed, the probability that a yearly return will fall within 20.3 percent of the mean of 11.8% will be approximately 2/3.
Individual Securities The characteristics of individual securities that are of interest are the:
Expected Return
Variance and Standard Deviation
Covariance and Correlation (to another security or index
Announcements, Surprises, and Expected Returns Any announcement can be broken down into two parts, the anticipated (or expected) part and the surprise (or innovation):  Announcement = Expected part + Surprise. The expected part of any announcement is the part of the

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