Question

Two stocks has the following year-end stock prices and dividends:

	Stock 1		Stock 2
Year	Price	Dividend	Price	Dividend
1	$70		$150
2	$75	$1	$163	$2
3	$74	$1	$156	$2
4	$80	$2	$173	$1

Which stock has a higher annual average capital gain yield over the four years? Which stock has a higher average dividend yield?If T-bill rate is 2.0 percent, which stock has a higher average nominal risk premium based on the annual average total return?What are the two primary lessons learned from capital market history? Provide evidence

Thanks

Answer 1

Stock 1

Annual average yield

(final stock price - Initial price)/(Initial price Xnumber of years) X 100

=

(80-70)/(70X3) X100

=

4.8

%

Stock 2

Annual average yield

(final stock price - Initial price)/(Initial price Xnumber of years) X 100

=

(173-150)/(150X3)X100

=

5.1

%

Stock 2 has higher capital gain yield

Stock 1

Dividend yield

Dividend/Current price

Dividend yield

Year 2

Year 3

Year 4

(1/75)

(1/74)

(2/80)

1.33%

1.35%

2.50%

Average yield

1.73%

Stock 2

Dividend yield

Year 2

Year 3

Year 4

(2/163)

(2/156)

(1/173)

1.23%

1.28%

0.58%

Average yield

1.03%

Stock 1 has higher average dividend yield

Average return on stock A

=

(Total capital gain + total dividends)/ Initial price

=

(80-70 + 1+1+2)/70

=

20.0%

Average return on stock B

=

(Total capital gain + total dividends)/ Initial price

=

18.7%

Risk premium on stock A

=

Average return - T bill rate

=

20.0%-2%

=

18.00%

Risk premium on stock B

=

Average return - T bill rate

=

18.7%-2%

=

16.7%

Stock 1 has higher nominal risk premium