Question

Explain the concepts:

A. Risk free return

B. Risk Premium

C. Efficient Market Hypothesis

D. Dividend Yield

Answer 1

A.Risk free return:

Risk free return is a return attributed to an investment that has no risk. The return on US treasury securities is an example of risk free rate.

B.Risk premium

Risk premium refers to the excess return above the risk free rate. It is the difference between risk free rate and the return on an investment. It is the return that investors require for bearing the risk.

C.Efficient market hypothesis

The theory of efficient market hypothesis was developed by Fama and French. They state that it is impossible for an investor to beat the market since market anomalies do not exist.

Efficient Market Hypothesis:

1.Weak form efficiency: Weak form efficiency assumes that all available information is reflected in the prices. So, it is not possible to use technical analysis to achieve high returns.

2.Semi-strong efficiency: Semi-strong efficiency assumes that stock prices have been factored all public information. So, it not possible to use fundamental analysis to beat the market.

3.Strong form efficiency: Strong efficiency assumes that all information, public and private are reflected in stock prices. So, it is not possible to use insider trading to beat the market.

D. Dividend yield

Dividend yield is the stock’s dividend as a percentage of the stock price. It is calculated using the below formula:

Dividend Yield= Annual dividend/Current stock price