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Key Chapter 7 Ms - Trang
Key Chapter 7 Ms - Trang
CHAPTER 7
RISK AND RETURN
1. Calculating Returns Suppose a stock had an initial price of $64 per share, paid a
dividend of $1.20 per share during the year, and had an ending share price of $73.
Compute the percentage total return. What was the dividend yield? The capital gains yield?
Answer:
The return of any asset is the increase in price, plus any dividends or cash flows, all divided by
theinitial price. The return of this stock is:
R= [(73 – 64) + 1.2] / $64
R=0.159, or 15.9%
The dividend yield is the dividend divided by price at the beginning of the period, so:
Dividend yield = $1.20 / 64 = 0.01878, or 1.88%
The capital gains yield is the increase in price divided by the initial price, so:
Capital gains yield = ($73 – 64) / $64 = 0.1406, or 14.06%
2. Calculating Returns Suppose you bought a bond with a 5.8 percent coupon rate one year
ago for $1,030. The bond sells for $1,059 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?
Answer:
The total dollar return is the change in price plus the coupon payment, so:
A. Total dollar return = $1,059 – 1,030 + 58
Total dollar return = $87
B. The total nominal percentage return of the bond is:R= [$1,059 – 1,030 + 58] / $1,030
=0.0844,or 8.44%
3. Calculating Returns and Variability Using the following returns, calculate the average
returns, the variances, and the standard deviations for X and Y:
Answer:
The average return for X = 41%/5
Large company stock average return = 8.2%
And the average return for Y over this period was = 57% / 5 =11.4%
Using the equation for variance, we find the variance for X over this period was:
Variance = 1/4[(0.09-0.082)^2+ (21%-8.2%)^2 + (-27%-8.2%)^2+ (15%-8.2%)^2 +(23%-
8.2%)^2] = 0.04172
And the standard deviation for X over this period was:
Standard deviation = (0.04172)^1/2 =20.4%
Using the equation for variance, we find the variance for Y over this period was:
Variance = Variance = 1/4[(12%-11.4%)^2+ (27%-11.4%)^2 + (-32%-11.4%)^2+ (14%-
11.4%)^2+(36%-11.4%)^2]= 0.06848
And the standard deviation for Y over this period was = (0.06848)^1/2=26.2%
4. Calculating Returns and Variability You’ve observed the following returns on SkyNet Data
Corporation’s stock over the past five years: 21 percent, 17 percent, 26 percent, 27 percent, and
4 percent.
a. What was the arithmetic average return on the company’s sck over this five-year period?
b. What was the variance of the company’s returns over this period? The standard deviation?
Answer:
a
To find the average return, we sum all the returs and divide by the number of returns,
Arithmetic average return = (0.21 +17% +26% +27% + 4%)/5=19%
b.
Variance = 1/4[(21%-19%)^2+ (17%-19%)^2 + (26%-19%)^2+ (27%-19%)^2 +(4%-
19%)^2]= 8.65.10^-3
And the standard deviation over this period was = (8.65.10^-3)^1/2=9.3%
.1531, or 15.31%
5. Holding Period Return A stock has had returns of 14.38 percent, 8.43 percent, 11.97
percent, 25.83 percent, and -9.17 percent over the past five years, respectively. What was the
holding period return for the stock?
Answer:
Apply the five-year holding-period return formula to calculate the total return of the stock over the
five-year period, we find:5-year holding-period return = [(1 +R1)(1 +R2)(1 +R3)(1 +R4)(1 +R5)]
–1
5-year holding-period return = [(1 + 14.38%)(1 + 8.43%)(1 + 11.97%)(1 + 25.83%)(1 –
9.17%)] – 1
5-year holding-period return = 58.7%
6. Calculating Returns You purchased a zero coupon bond one year ago for $160.53. The
market interest rate is now 7.5 percent. If the bond had 25 years to maturity when you originally
purchased it, what was your total return for the past year?
Answer:
To find the return on the zero coupon bond, we first need to find the price of the bond today.
Since one year has elapsed, the bond now has 24 years to maturity. The price today is:
P1= $1,000/1.075^24
P1= $176.27
There are no intermediate cash flows on a zero coupon bond, so the return is the capital gains,
or:
R= ($176.27-160.53) / $160.53
R = 9.8%
7. Calculating Returns and Variability You find a certain stock that had returns of 12 percent,
21.5 percent, 13 percent, and 27 percent for four of the last five years. If the average return of
the stock over this period was 10.5 percent, what was the stock’s return for the missing year?
What is the standard deviation of the stock’s returns?
Answer:
Here we know the average stock return, and four of the five returns used to compute the average
return. We can work the average return equation backward to find the missing return. The
average return is calculated as: 5(10.5%) = 12% + 21.5% +13% + 27% +R
R= -21%
The missing return has to be -21 percent.
ÔN THI ATC – MS. TRANG
Concept Questions and Exercises CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe
Answer:
The expected return of an asset is the sum of the probability of each state occurring times the
rate of return if that state occurs. So, the expected return of each stock asset is:
E(RA) = .30(.06) + .55(.07) + .15(.11) = .073, or 7.3%
E(RB) = .30(–.20) + .55(.13) + .15(.33) = .061, or 6.1%
To calculate the standard deviation, we first need to calculate the variance. To find the variance,
we find the squared deviations from the expected return. We then multiply each possible squared
deviation by its probability, and then add all of these up. The result is the variance. So, the
variance and standard deviation of each stock are:
σA2 = .30(.06 - .073)2 + .55(.07-.073)2 + .15(.11-.0đc3)2 = 0.00026
σA = 0.0161 = 1.61%
σB2 = .30(-.20 - .061)2 + .55(.13-.061)2 + .15(.33-.061)2 = 0.0339
σB = 0.1841 = 18.41%
10. Arithmetic and Geometric Returns A stock has had returns of 24 percent, 12 percent, 38
percent, 22 percent, 21 percent, and 216 percent over the last six years. What are the arithmetic
and geometric returns for the stock?
Answer:
The arithmetic average return is the sum of the known returns divided by the number of returns,
so:
Arithmetic average return = (.24 + .12 + .38 +.22 + .21 + 2.16) / 6
Arithmetic average return = .555, or 55.5%
Using the equation for the geometric return, we find:
Geometric average return = [(1+R1)(1+R2)(1+R3)…(1+RT)]1/T – 1
Geometric average return = [(1+.24)(1+.12)(1+.38)(1+.22)(1+.21)(1+2.16)]1/6 - 1
Geometric average return = 0.409 = 40.9%
Remember, the geometric average return will always be less than the arithmetic average return if
thereturns have any variation.
11. Arithmetic and Geometric Returns A stock has had the following year-end prices and
dividends. Determine the arithmetic and geometric returns for the stock.
Answer:
To calculate the arithmetic and geometric average returns, we must first calculate the return for
eachyear. The return for each year is:
R1 = ($77.98 – 73.18 + 1.15) / $73.18 = 0.0813, or 8.13%
R2= ($69.13 – 77.98 + 1.25) / $77.98 = -0.0975, or -9.75%
R3 = ($84.65 – 69.13 + 1.36) / $69.13 = .2442, or 24.42%
R4 = ($91.37 – 84.65 + 1.47) / $84.65 = .0968, or 9.68%
R5= ($103.66 – 91.37 + 1.60) / $91.37 = .1520, or 15.20%
The arithmetic average return was:
RA = (0.0813 + -0.0975 + 0. 2442 + 0. 0968 + 0.1520)/5 =
And the geometric average return was:
RG = [(1+0.0813)(1-0.0975)(1+0.2442)(1+0.0968)(1+0.1520)]1/5 – 1=
12. Covariance and Correlation Based on the following information, calculate the expected
return and standard deviation of each of the following stocks. Assume each state of the economy
is equally likely to happen. What are the covariance and correlation between the returns of the
two stocks?
ÔN THI ATC – MS. TRANG
Concept Questions and Exercises CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe
Answer:
The expected return of an asset is the sum of the probability of each state occurring times the
rate ofreturn if that state occurs. So, the expected return of each stock is:
E(RA) = .33(.108) + .33(.126) + .33(.064) = .0983, or 9.83%
E(RB) = .33(–.067) + .33(.113) + .33(.276) = .1063, or 10.63%
To calculate the standard deviation, we first need to calculate the variance. To find the variance,
wefind the squared deviations from the expected return. We then multiply each possible
squareddeviation by its probability, and then add all of these up. The result is the variance. So,
the varianceand standard deviation of Stock A are:
σA2 = .33(.108 - .0983)2 + .33(.126 - .0983)2 + .33(.064 - .0983)2 = 0.00067
σA = 0.0259 = 2.59%
And the standard deviation of Stock B is:
σB2 = .33(-.067 - .1063)2 + .33(.113 - .1063)2 + .33(.276 - .1063)2 = 0.0194
σB = 0.1393 = 13.93%
To find the covariance, we multiply each possible state times the product of each assets’
deviationfrom the mean in that state. The sum of these products is the covariance. So, the
covariance is:
Cov(A,B) = .33(.108 - .0983) (-.067 - .1063) + .33(.126 - .0983) (.113 - .1063) + 33(.064 -
.0983) (.276 - .1063) = - 0.002414
And the correlation is:
ρA,B = Cov(A,B)/ σA σB = - 0.002414/ (0.0259) (0.1393) = -0.6691
13. Covariance and Correlation Based on the following information, calculate the expected
return and standard deviation for each of the following stocks. What are the covariance and
correlation between the returns of the two stocks?