McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 9-0 Corporate Finance Ross  Westerfield  Jaffe Seventh Edition.

Slides:



Advertisements
Similar presentations
Chapter Outline 9.1 Returns 9.2 Holding-Period Returns
Advertisements

Risk and Return – Introduction Chapter 9 For 9.220,
1 1 C h a p t e r A Brief History of Risk and Return second edition Fundamentals of Investments Valuation & Management Charles J. Corrado Bradford D. Jordan.
Risk and Return: Lessons from Market History Chapter 10 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
Chapters 9 & 10 – MBA504 Risk and Returns Return Basics –Holding-Period Returns –Return Statistics Risk Statistics Return and Risk for Individual Securities.
Risk, Return, and Discount Rates Capital Market History The Risk/Return Relation Applications to Corporate Finance.
1 1 C h a p t e r A Brief History of Risk and Return second edition Fundamentals of Investments Valuation & Management Charles J. Corrado Bradford D. Jordan.
Chapter McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. 1 A Brief History of Risk and Return.
© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Some Lessons From Capital Market History Chapter Twelve.
Chapter McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. 12 Some Lessons from Capital Market History.
Chapter 9 Outline 9.1Returns 9.2Holding-Period Returns 9.3Return Statistics 9.4Average Stock Returns and Risk-Free Returns 9.5Risk Statistics 9.6Summary.
© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Some Lessons From Capital Market History Chapter Twelve.
Chapter 12 Some Lessons from Capital Market History McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
1 1 C h a p t e r A Brief History of Risk and Return second edition Fundamentals of Investments Valuation & Management Charles J. Corrado Bradford D. Jordan.
McGraw-Hill © 2004 The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Some Lessons from Capital Market History Chapter 10.
Capital Market Theory Return & Risk Calculations, Risk Premiums, and Historical Averages.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 10 Some Lessons from Capital Market History.
Risk, Return, and Discount Rates Capital Market History The Risk/Return Relation Application to Corporate Finance.
A Brief History of Risk and Return
Risk, Return, and Discount Rates Capital Market History The Risk/Return Relation Applications to Corporate Finance.
Finance 300 Financial Markets Lecture 1 Professor J. Petry, Fall, 2002©
Copyright © 2014 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin.
Jacoby, Stangeland and Wajeeh, uDollar Return = Dollar Dividend + Change in Market Value uPercentage Return = Dollar Return / Beginning Market Value.
Risk and Return – Introduction For 9.220, Term 1, 2002/03 02_Lecture12.ppt Student Version.
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Risk and Return: Lessons from Market History Module 5.1.
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies,
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 0 Chapter 10 Some Lessons from Capital Market History.
12-1 Some Lessons from Capital Market History Chapter 12 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
1-1 1 A Brief History of Risk and Return. 1-2 A Brief History of Risk and Return Two key observations: 1. There is a substantial reward, on average, for.
10-1 Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin.
© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Some Lessons From Capital Market History Chapter Twelve Prepared by Anne Inglis, Ryerson University.
Last Week.. Capital Budgeting Techniques Non-Conventional Cash Flows
12-0 Some Lessons from Capital Market History Chapter 12 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
Capital Market Efficiency. Risk, Return and Financial Markets Lessons from capital market history –There is a reward for bearing risk –The greater the.
10.0 Chapter 10 Some Lessons from Capital Market History.
Chapter McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. A Brief History of Risk and Return 1.
1 Chapter 1 Brief History of Risk and Return Ayşe Yüce – Ryerson University Copyright © 2012 McGraw-Hill Ryerson.
Chapter McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 1 A Brief History of Risk and Return.
Chapter 12 Some Lessons from Capital Market History McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 10 Some Lessons from Capital Market History.
Chapter 10: Risk and return: lessons from market history
Lecture Topic 9: Risk and Return
A History of Risk and Return
Risk and Return: Lessons from Market History Chapter 10 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
© 2009 McGraw-Hill Ryerson Limited 1-1 Chapter 1 A Brief History of Risk and Return Prepared by Ayşe Yüce Ryerson University.
T12.1 Chapter Outline Chapter 12 Some Lessons from Capital Market History Chapter Organization 12.1Returns 12.2The Historical Record 12.3Average Returns:
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved CHAPTER 9 Risk and Return Lessons from Market History.
Chapter McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. A Brief History of Risk and Return 1.
McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 9-0 Corporate Finance Ross  Westerfield  Jaffe Seventh Edition.
Risk and Return 1Finance - Pedro Barroso. Returns Dollar Returns the sum of the cash received and the change in value of the asset, in dollars Time01.
Introduction to Risk The pricing of Risky Assets.
McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 5-1 Chapter 5 History of Interest Rates and Risk Premiums.
McGraw-Hill/IrwinCopyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Risk and Return Lessons from Market History Chapter 10.
McGraw-Hill/Irwin ©2001 The McGraw-Hill Companies All Rights Reserved 10.0 Chapter 10 Some Lessons from Capital Market History.
1-1 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. A Brief History of Risk and Return 1.
9-0 McGraw-Hill Ryerson © 2003 McGraw–Hill Ryerson Limited Corporate Finance Ross  Westerfield  Jaffe Sixth Edition 9 Chapter Nine Capital Market Theory:
Corporate Finance Ronald F. Singer FINA 4330 Risk and Return Lecture 11 Fall 2010.
10-0 McGraw-Hill Ryerson © 2005 McGraw–Hill Ryerson Limited Chapter Outline 10.1Returns 10.2Holding-Period Returns 10.3Return Statistics 10.4Average Stock.
We can examine returns in the financial markets to help us determine the appropriate returns on non-financial assets (e.g., capital investments by firms)
Some lessons from capital market history Chapter 10.
McGraw-Hill/Irwin ©2001 The McGraw-Hill Companies All Rights Reserved 10.0 Chapter 10 Some Lessons from Capital Market History.
0 Risk and Return: Lessons from Market History Chapter 10.
McGraw-Hill/Irwin Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved. 9-0 CHAPTER 9 Capital Market Theory: An Overview.
G. M. Wali Ullah Lecturer, School of Business Independent University, Bangladesh (IUB) Chapter 10 Risk and Return FIN 302 (3) Copyright.
0 Chapter 12 Some Lessons from Capital Market History Chapter Outline Returns The Historical Record Average Returns: The First Lesson The Variability of.
Holding Period Returns
Some Lessons from Capital Market History
Return, Risk, and the SML RWJ-Chapter 13.
Risk and Return Lessons from Market History
Presentation transcript:

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 9-0 Corporate Finance Ross  Westerfield  Jaffe Seventh Edition 9 Chapter Nine Capital Market Theory: An Overview

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 9-1 Chapter Outline 9.1Returns 9.2Holding-Period Returns 9.3Return Statistics 9.4Average Stock Returns and Risk-Free Returns 9.5Risk Statistics 9.6Summary and Conclusions

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Returns Dollar Returns –the sum of the cash received and the change in value of the asset, in dollars. Time01 Initial investment Ending market value Dividends Percentage Returns –the sum of the cash received and the change in value of the asset divided by the original investment.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 9-3 Dollar Return = Dividend + Change in Market Value 9.1Returns

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Returns: Example Suppose you bought 100 shares of Wal-Mart (WMT) one year ago today at $25. Over the last year, you received $20 in dividends (= 20 cents per share × 100 shares). At the end of the year, the stock sells for $30. How did you do? Quite well. You invested $25 × 100 = $2,500. At the end of the year, you have stock worth $3,000 and cash dividends of $20. Your dollar gain was $520 = $20 + ($3,000 – $2,500). Your percentage gain for the year is 20.8% = $2,500 $520

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Returns: Example Dollar Return: $520 gain Time01 -$2,500 $3,000$20 Percentage Return: 20.8% = $2,500 $520

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Holding-Period Returns The holding period return is the return that an investor would get when holding an investment over a period of n years, when the return during year i is given as r i :

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 9-7 Holding Period Return: Example Suppose your investment provides the following returns over a four-year period:

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 9-8 Holding Period Return: Example An investor who held this investment would have actually realized an annual return of 9.58%: So, our investor made 9.58% on his money for four years, realizing a holding period return of 44.21%

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. 9-9 Holding Period Return: Example Note that the geometric average is not the same thing as the arithmetic average:

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Holding Period Returns A famous set of studies dealing with the 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 Bills

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved The Future Value of an Investment of $1 in 1925 $59.70 $17.48 Source: © Stocks, Bonds, Bills, and Inflation 2003 Yearbook™, Ibbotson Associates, Inc., Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). All rights reserved. $1,775.34

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Return Statistics The history of capital market returns can be summarized by describing the –average return –the standard deviation of those returns –the frequency distribution of the returns.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Historical Returns, Source: © Stocks, Bonds, Bills, and Inflation 2003 Yearbook™, Ibbotson Associates, Inc., Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). All rights reserved. – 90%+ 90%0% Average Standard Series Annual Return DeviationDistribution Large Company Stocks12.2%20.5% Small Company Stocks Long-Term Corporate Bonds Long-Term Government Bonds U.S. Treasury Bills Inflation3.14.4

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Average Stock Returns and Risk-Free Returns The Risk Premium is the additional return (over and above the risk-free rate) resulting from bearing risk. One of the most significant observations of stock market data is this long-run excess of stock return over the risk- free return. –The average excess return from large company common stocks for the period 1926 through 1999 was 8.4% = 12.2% – 3.8% –The average excess return from small company common stocks for the period 1926 through 1999 was 13.2% = 16.9% – 3.8% –The average excess return from long-term corporate bonds for the period 1926 through 1999 was 2.4% = 6.2% – 3.8%

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Risk Premia Suppose that The Wall Street Journal announced that the current rate for one-year Treasury bills is 5%. What is the expected return on the market of small-company stocks? Recall that the average excess return from small company common stocks for the period 1926 through 1999 was 13.2% Given a risk-free rate of 5%, we have an expected return on the market of small-company stocks of: 18.2% = 13.2% + 5%

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved The Risk-Return Tradeoff

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Rates of Return Source: © Stocks, Bonds, Bills, and Inflation 2000 Yearbook™, Ibbotson Associates, Inc., Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). All rights reserved.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Risk Premiums Rate of return on T-bills is essentially risk-free. Investing in stocks is risky, but there are compensations. The difference between the return on T-bills and stocks is the risk premium for investing in stocks. An old saying on Wall Street is “You can either sleep well or eat well.”

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Stock Market Volatility Source: © Stocks, Bonds, Bills, and Inflation 2000 Yearbook™, Ibbotson Associates, Inc., Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). All rights reserved. The volatility of stocks is not constant from year to year.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved 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.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Normal Distribution A large enough sample drawn from a normal distribution looks like a bell-shaped curve. Probability Return on large company common stocks 99.74% – 3  – 49.3% – 2  – 28.8% – 1  – 8.3% % + 1  32.7% + 2  53.2% + 3  73.7% The probability that a yearly return will fall within 1 standard deviation of the mean will be approximately ⅔ (67%) % 95.44%

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Normal Distribution The 20.1-percent standard deviation we found for stock returns from 1926 through 1999 can now be interpreted in the following way: if stock returns are approximately normally distributed, the probability that a yearly return will fall within 20.1 percent of the mean of 13.3 percent will be approximately 2/3.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Normal Distribution Source: © Stocks, Bonds, Bills, and Inflation 2002 Yearbook™, Ibbotson Associates, Inc., Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). All rights reserved.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Summary and Conclusions This chapter presents returns for four asset classes: –Large Company Stocks: 12.2% –Small Company Stocks: 16.9% –Long-Term Government Bonds: 5.8% –Treasury Bills: 3.8% Stocks have outperformed bonds over most of the twentieth century, although stocks have also exhibited more risk.

McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved Summary and Conclusions The stocks of small companies have outperformed the stocks of large companies over most of the twentieth century, again with more risk. The statistical measures in this chapter are necessary building blocks for the material of the next three chapters.