Fundamentals of corporate finance 10e ROSS JORDAN chap012
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Chapter 12
Some Lessons from Capital Market History
12-1
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
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12-2
Returns
The Historical Return
Average Returns: The 1
st
Lesson
The Variability of Returns: The 2
More about Average Returns
Capital Market Efficiency
nd
Lesson
Chapter Outline
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12-3
Returns
The Historical Return
Average Returns: The 1
st
Lesson
The Variability of Returns: The 2
More about Average Returns
Capital Market Efficiency
nd
Lesson
Risk, Return and
Financial Markets
Looking back through time we know…..
1.There is a reward for bearing risk
2.The > the risk = the > the potential return!
12-4
This is called: The Risk/Return
Trade-of
12-5
Dollar Returns
Total dollar return =
income from investment
+ capital gain (or loss) due to the
change in price
12-6
What is my return?
12-7
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You bought a bond for $950 one year ago.
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You have received two coupons of $30 each.
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You can sell the bond for $975 today.
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What is your total dollar return?
What is my return?
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Income = 30 + 30 = 60
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Capital Gain =
975 - 950 = 25
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Total Dollar return =
60 + 25 = $85
12-8
Percentage Returns
It is generally more intuitive to
think in terms of percentage,
(rather than dollar), returns
12-9
Percentage Returns
1.
Dividend Yield = income/beginning
price
2.
Capital Gains Yield = (ending price – beginning price) /
beginning price
3.
Total percentage return = dividend yield + capital gains
yield
12-10
Percentage Returns
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You bought a stock for $35.
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You received dividends of
$1.25.
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The stock is now selling for
$40.
12-11
Percentage Returns
1.
Dividend Yield = income/beginning
price
1.25 / 35 = 3.57%
2.
Capital Gains Yield = (ending price – beginning price) / beginning
price
(40 – 35) / 35 = 14.29%
3.
Total percentage return = dividend yield + capital gains yield
3.57 + 14.29 = 17.86%
12-12
The Importance of
Financial Markets
Financial markets allow companies, governments and
individuals to increase their utility/wealth
Savers have the ability to invest in financial assets so that they
can defer consumption and earn a return to compensate them for
doing so
Borrowers have better access to the capital that is available so
that they can invest in productive assets
12-13
The Importance of
Financial Markets
Financial markets also provide
us with information about the
returns that are required for
various levels of risk
12-14
Chapter Outline
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12-15
Returns
The Historical Return
Average Returns: The 1
st
Lesson
The Variability of Returns: The 2
More about Average Returns
Capital Market Efficiency
nd
Lesson
12-16
Year-to-Year Total Returns
Large-Company
Stock Returns
Large Companies
Long-Term Government
Bond Returns
U.S. Treasury Bill Returns
12-17
Long-Term Government Bonds
U.S. Treasury Bills
Chapter Outline
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12-18
Returns
The Historical Return
Average Returns: The 1
st
Lesson
The Variability of Returns: The 2
More about Average Returns
Capital Market Efficiency
nd
Lesson
A Comparison of
Average Returns
Investment
12-19
Average Return
Large Stocks
12.3%
Small Stocks
17.1%
Long-term Corporate Bonds
6.2%
Long-term Government Bonds
5.8%
U.S. Treasury Bills
3.8%
Inflation
3.1%
Now let’s add risk to the picture
12-20
Risk Premiums
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The “extra” return earned for taking on risk
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Treasury bills are considered to be risk-free
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The risk premium is the return over and above the
risk-free rate
12-21
Average Annual Returns and Risk
Premiums
Investment
12-22
Average Return
Risk Premium
Large Stocks
12.3%
8.5%
Small Stocks
17.1%
13.3%
Long-term Corporate Bonds
6.2%
2.4%
Long-term Government Bonds
5.8%
2.0%
U.S. Treasury Bills
3.8%
0.0%
Chapter Outline
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12-23
Returns
The Historical Return
Average Returns: The 1
st
Lesson
The Variability of Returns: The 2
More about Average Returns
Capital Market Efficiency
nd
Lesson
12-24
Variance and Standard Deviation
12-25
