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slides09 - 9 Risk and return In these slides we will...

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9. Risk and return In these slides, we will address the following questions: How do we measure the expected rewards for holding risky assets? How do we measure risk? What can we say about the risk-reward relationship?
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Returns To talk about capital markets, we first review how to compute returns. When we speak of “returns”, we always mean holding period returns . Stocks: dividend yield plus capital gain rate Bonds: current yield plus capital gain rate 2
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Historical record The historical record suggests that returns earned by different classes of assets have different (statistical) characteristics. 3
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Figure — Historical asset prices Based on this data, what class of assets has the highest expected return? The lowest? 4
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Figure — Returns Small cap stocks 5
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Figure — Returns (continued) Large cap stocks 6
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Figure — Returns (continued) Long-term US Treasury Bonds 7
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Figure — Returns (continued) US Treasury Bills 8
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Figure — Inflation 9
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Remarks Investing in risky assets is well-rewarded. Returns on T-bills are small but steady. Long-term bonds do much better than short-term, espcially after 1980. Returns on small caps are large on average, but highly vari- able. The greater the risk, the greater the average return. Although returns are relatively unpredictable from one year to the next (daily returns are even less predictable), they are relatively stable over longer time periods (e.g., 30 years). It might actually be more interesting to see the figures after correcting for inflation.
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