Fundamentals of Corporate Finance
11th Edition
ISBN: 9780077861704
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Bradford D Jordan Professor
Publisher: McGraw-Hill Education
expand_more
expand_more
format_list_bulleted
Concept explainers
Videos
Textbook Question
Chapter 12, Problem 3CRCT
Risk and Return [LO2, 3] We have seen that over long periods, stock investments have tended to substantially outperform bond investments. However, it is common to observe investors with long horizons holding entirely bonds. Are such investors irrational?
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Which of these statements below are correct?
(a) Small arbitrage opportunities may occasionally exist in real markets due to lack of information.
(b) If there is an arbitrage opportunity, it means one can make a risk-free profit.
(c) Arbitrary investments and arbitrage generating investments are basically the same
(d) The no-arbitrage price of a bond is equal to its present value.
(e)The law of one price is based on the no-arbitrage assumption.
We have seen that over long periods, stock investments have tended to substantially outperform bond investments. However, it is common to observe investors with long horizons holding portfolios composed entirely of bonds. Are such investors irrational?
Which one of the following expressions about risk and returns is wrong?
A. In general, one reason why a stock is riskier than a bond is that because cash flows from a bond are known and promised, whereas cash flows from a stock are neither known nor promised.
B. According to CAPM model, a well-diversified portfolio will have a beta which equals to 0.
C. Risk premium is the extra return provided on risky assets to compensate for risk. The difference between risky return and the risk-free return.
D. Unexpected return happened because new information came to light which caused our expectations about prices and returns to change.
Chapter 12 Solutions
Fundamentals of Corporate Finance
Ch. 12.1 - Prob. 12.1ACQCh. 12.1 - Why are unrealized capital gains or losses...Ch. 12.1 - What is the difference between a dollar return and...Ch. 12.2 - Prob. 12.2ACQCh. 12.2 - Why doesnt everyone just buy small stocks as...Ch. 12.2 - What was the smallest return observed over the 88...Ch. 12.2 - About how many times did large-company stocks...Ch. 12.2 - What was the longest winning streak (years without...Ch. 12.2 - How often did the T-bill portfolio have a negative...Ch. 12.3 - Prob. 12.3ACQ
Ch. 12.3 - What was the real (as opposed to nominal) risk...Ch. 12.3 - Prob. 12.3CCQCh. 12.3 - What is the first lesson from capital market...Ch. 12.4 - In words, how do we calculate a variance? A...Ch. 12.4 - With a normal distribution, what is the...Ch. 12.4 - Prob. 12.4CCQCh. 12.4 - What is the second lesson from capital market...Ch. 12.5 - Prob. 12.5ACQCh. 12.5 - Prob. 12.5BCQCh. 12.6 - What is an efficient market?Ch. 12.6 - Prob. 12.6BCQCh. 12 - Chase Bank pays an annual dividend of 1.05 per...Ch. 12 - The risk premium is computed as the excess return...Ch. 12 - Prob. 12.4CTFCh. 12 - Prob. 12.5CTFCh. 12 - Prob. 12.6CTFCh. 12 - Investment Selection [LO4] Given that Fannie Mae...Ch. 12 - Prob. 2CRCTCh. 12 - Risk and Return [LO2, 3] We have seen that over...Ch. 12 - Market Efficiency Implications [LO4] Explain why a...Ch. 12 - Efficient Markets Hypothesis [LO4] A stock market...Ch. 12 - Semistrong Efficiency [LO4] If a market is...Ch. 12 - Efficient Markets Hypothesis [LO4] What are the...Ch. 12 - Stocks versus Gambling [LO4] Critically evaluate...Ch. 12 - Efficient Markets Hypothesis [LO4] Several...Ch. 12 - Efficient Markets Hypothesis [LO4] For each of the...Ch. 12 - Calculating Returns [LO1] Suppose a stock had an...Ch. 12 - Calculating Yields [LO1] In Problem 1, what was...Ch. 12 - Prob. 3QPCh. 12 - Prob. 4QPCh. 12 - Nominal versus Real Returns [LO2] What was the...Ch. 12 - Bond Returns [LO2] What is the historical real...Ch. 12 - Prob. 7QPCh. 12 - Risk Premiums [LO2, 3] Refer to Table 12.1 in the...Ch. 12 - Calculating Returns and Variability [LO1] Youve...Ch. 12 - Calculating Real Returns and Risk Premiums [LO1]...Ch. 12 - Calculating Real Rates [LO1] Given the information...Ch. 12 - Prob. 12QPCh. 12 - Prob. 13QPCh. 12 - Calculating Returns and Variability [LO1] You find...Ch. 12 - Arithmetic and Geometric Returns [LO1] A stock has...Ch. 12 - Arithmetic and Geometric Returns [LO1] A stock has...Ch. 12 - Using Return Distributions [LO3] Suppose the...Ch. 12 - Prob. 18QPCh. 12 - Distributions [LO3] In Problem 18, what is the...Ch. 12 - Blumes Formula [LO1] Over a 40-year period an...Ch. 12 - Prob. 21QPCh. 12 - Calculating Returns [LO2, 3] Refer to Table 12.1...Ch. 12 - Using Probability Distributions [LO3] Suppose the...Ch. 12 - Using Probability Distributions [LO3] Suppose the...Ch. 12 - Prob. 1MCh. 12 - Prob. 2MCh. 12 - Prob. 3MCh. 12 - Prob. 4MCh. 12 - A measure of risk-adjusted performance that is...Ch. 12 - Prob. 6M
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Select all the correct statements. a. The no-arbitrage price of a bond is equal to its present value. b. If there is an arbitrage opportunity, it means one can make a risk-free profit. c. Small arbitrage opportunities may occasionally exist in real markets due to lack of information. d. The law of one price is based on the no-arbitrage assumption. e. Arbitrary investments and arbitrage generating investments are basically the samearrow_forwardfinancial risk management fill in the blacks with correct answer. Interest rate risk is the potential for investment (....loss/gain..........). that result from a change in the interest rates. If interest rate (rise/fall)..., for instance, the value of the bond or fixed-income instrument will decline.arrow_forwardb. Assume tḥat you maintain bonds and money market securities in your portfolio and you suddenly believe that long-term interest rates will rise substantially tomorrow (even though the market does not share the same view), while short term interest rates will remain the same. i. How would you rebalance your portfolio between bonds and money market securities?arrow_forward
- Given that higher-risk investments, such as small-company stocks, have outperformed other investments over time, why don’t all investors choose to invest only in these high-risk securities? (Answer the question correctly and in-depth.)arrow_forwardHow do stocks and bonds differ in terms of the future payments that they are expected to make? Which type of investment (stocks or bonds) is considered to be more risky? Given what you know, which investment (stocks or bonds) do you think commonly goes by the nickname “fixed income”?arrow_forward1. What effect does increasing inflation expectations have on the required returns of investors in common stock? 2. Explain the specific relationship between risk and reward and why this relationship must be true.arrow_forward
- Which statement is TRUE regarding the riskiness of money market instruments and capital market instruments? * Changing economic prospects can cause very large changes in current stock values. Distant cash flows for stocks can be known with certainty, make them riskier than money market instruments. Money market instruments have predictable cash flows and mature in one year or less, so they are much more risky. The prices of long-term capital market instruments are less sensitive to changes in interest rates than prices of short-term instruments.arrow_forwardExplain these three 1. PURCHASING POWER RISK - is perhaps, more difficult to recognize than the other types of risk. It is easy to observe the decline in the price of a stock or bond, but it is often more difficult to recognize that the purchasing power of the return you have earned on investment has declined (risen) as a result of inflation (deflation). 2. INTEREST RATE RISK - Because money has time value, fluctuations in interest rates will cause the value of an investment to fluctuate also. Although interest rate risk is most commonly associated with bond price movements, rising interest rates cause bond prices to decline and declining interest rates cause bond prices to rise. 3. BUSINESS RISK - refers to the uncertainty about the rate of a return caused by the nature of the business. The most frequently discussed causes of business risk are uncertainty about the firm's sales and operating expenses.arrow_forwardThe so-called ``flight to quality'', which happens during a financial crisis, causes the risk premium between risky and risk-free securities to be Question 6 options: eliminated. reduced. unchanged (there is no effect). increased.arrow_forward
- If the credit quality of the issuer falls sharply, what is your main concern? a.The share price. b.The volatility of the underlying c.The default risk. d.A rise in risk free interest rates Give typing answer with explanation and conclusionarrow_forwardWhich of the following statements is TRUE? O The demand for a bond declines when it becomes less liquid, decreasing the interest rate spread between it and relatively more liquid bonds. O The corporate bond market is the most liquid bond market. O The differences in bond interest rates reflect differences in default risk only. O A liquid asset is one that can be quickly and cheaply converted into cash.arrow_forwardUnsystematic risk is * a.the risk associated with movements in securities prices B.higher when interest rates rise C.the risk of loss of purchasing power D.reduced through diversificationarrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
What are Money Markets?; Author: The CISI;https://www.youtube.com/watch?v=ipOYM0sfW7M;License: Standard Youtube License