Principles of Corporate Finance_ 12th Edition

bre44380_ch07_162-191.indd 186 09/02/15 04:11 PM

186 Part Two Risk

For international evidence on market returns since 1900, see:

E. Dimson, P. R. Marsh, and M. Staunton, Triumph of the Optimists: 101 Years of Investment Returns

(Princeton, NJ: Princeton University Press, 2002). More recent data is available in The Credit

Suisse Global Investment Returns Yearbook at https://publications.credit-suisse.com/tasks/

render/file/?fileID=AE924F44-E396-A4E5-11E63B09CFE37CCB.

The Ibbotson Yearbook is a valuable record of the performance of U.S. securities since 1926:

Ibbotson Stocks, Bonds, Bills, and Inflation 2011 Yearbook (Chicago, IL: Morningstar, Inc., 2012).

Useful books and reviews on the equity risk premium include:

B. Cornell, The Equity Risk Premium: The Long-Run Future of the Stock Market (New York: Wiley,

1999).

P. Fernandez, P. Linares, and I. Fernandez Acín, “Market Risk Premium Used in 88 Countries in 2014:

A Survey with 8,228 Answers,” June 20, 2014, Available at http://ssrn.com/abstract=2450452.

W. Goetzmann and R. Ibbotson, The Equity Risk Premium: Essays and Explorations (Oxford Univer-

sity Press, 2006).

R. Mehra (ed.), Handbook of Investments: Equity Risk Premium 1 (Amsterdam, North-Holland, 2007).

R. Mehra and E. C. Prescott, “The Equity Risk Premium in Prospect,” in Handbook of the Economics

of Finance, eds. G. M. Constantinides, M. Harris, and R. M. Stulz (Amsterdam, North-Holland,

2003) Vol 1, Part 2, pp. 889–938.

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FURTHER

READING

Select problems are available in McGraw-Hill’s Connect.

Please see the preface for more information.

BASIC

1. Expected return and standard deviation A game of chance offers the following odds and
   payoffs. Each play of the game costs $100, so the net profit per play is the payoff less $100.

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PROBLEM

SETS

Probability Payoff Net Profit

0.10 $500 $400

0.50 100 0

0.40 0 – 100

What are the expected cash payoff and expected rate of return? Calculate the variance and

standard deviation of this rate of return.

2. Standard deviation of returns The following table shows the nominal returns on the U.S.
   stocks and the rate of inflation.
   a. What was the standard deviation of the nominal market returns?
   b. Calculate the arithmatic average real return.

Year Nominal Return (%) Inflation (%)

2010 17.2 1.5

2011 1.0 3.0

2012 16.1 1.7

2013 33.1 1.5

2014 12.7 0.8