Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
CHAPTER 12
SOME LESSONS FROM CAPITAL
MARKET HISTORY
Answers to Concepts Review and Critical Thinking Questions
1. They all wish they had! Since they didn’t, it must have been the case that the stellar performance was
9. The EMH only says, within the bounds of increasingly strong assumptions about the information
CHAPTER 12 - 2
b. Under (2), if the market is not semi-strong form efficient, then this information could be used to
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
CHAPTER 12 - 3
4. The total dollar return is the increase in price plus the coupon payment, so:
5. The nominal return is the stated return, which is 11.90 percent. Using the Fisher equation, the real
return was:
6. Using the Fisher equation, the real returns for long-term government and corporate bonds were:
7. The average return is the sum of the returns, divided by the number of returns. The average return for each
stock was:
CHAPTER 12 - 4
8. We will calculate the sum of the returns for each asset and the observed risk premium first. Doing so,
we get:
CHAPTER 12 - 5
b. Using the equation for variance, we find the variance for large company stocks over this period
was:
c. The average observed risk premium over this period was:
9. a. To find the average return, we sum all the returns and divide by the number of returns, so:
CHAPTER 12 - 6
b. Using the equation to calculate variance, we find:
10. a. To calculate the average real return, we can use the average return of the asset, and the average
inflation in the Fisher equation. Doing so, we find:
11. We can find the average real risk-free rate using the Fisher equation. The average real risk-free rate
was:
CHAPTER 12 - 7
Intermediate
13. To find the real return, we first need to find the nominal return, which means we need the current price
of the bond. Going back to the chapter on pricing bonds, we find the current price is:
14. 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:
15. The arithmetic average return is the sum of the known returns divided by the number of returns, so:
CHAPTER 12 - 8
16. To calculate the arithmetic and geometric average returns, we must first calculate the return for each
year. The return for each year is:
17. Looking at the long-term corporate bond return history in Figure 12.10, we see that the mean return
CHAPTER 12 - 9
18. The mean return for small company stocks was 16.7 percent, with a standard deviation of 32.6 percent.
20. To find the best forecast, we apply Blume’s formula as follows:
21. The best forecast for a one year return is the arithmetic average, which is 11.9 percent. The geometric
CHAPTER 12 - 10
22. To find the real return we need to use the Fisher equation. Rewriting the Fisher equation to solve for
the real return, we get:
a. The average return for T-bills over this period was:
b. Using the equation for variance, we find the variance for T-bills over this period was:
CHAPTER 12 - 11
c. The average observed real return over this period was:
Challenge
23. Using the z-statistic, we find:
24. For each of the questions asked here, we need to use the z-statistic, which is:
CHAPTER 12 - 12
And the probability that T-bill returns will be less than 0 percent is:
