Risk and Return: Past and Prologue

1
CHAPTER 5

• Risk and Return Past and Prologue

2
What is investment risk?

• Typically, investment returns are not known with
  certainty.
• Investment risk relates to
• possibility of a ________________
• the probability of earning _______ than expected.
• _____________________________ associated with the
  returns.

3
Risk

• Risk is important because most investors are
  _____________ ___________________.
• If investors are risk averse, they must be
  compensated for accepting risks.

4
Annual Holding Period ReturnsFrom Table 5.3 of
Text

• Geom. Arith. Stan.
• Series Mean Mean Dev.
• World Stk 9.41 11.17 18.38
• US Lg Stk 10.23 12.25 20.50
• US Sm Stk 11.80 18.43 38.11
• Wor Bonds 5.34 6.13 9.14
• LT Treas 5.10 5.64 8.19
• T-Bills 3.71 3.79 3.18
• Inflation 2.98 3.12 4.35

5
Figure 5.1 Frequency Distributions of Returns
6
Figure 5.3 Normal Distribution with Mean of
12.25 and s of 20.50
7
Real vs. Nominal Rates

• Fisher effect Approximation
• nominal rate real rate inflation premium
• R r i or r R - i
• Example r 3, i 6
• R 9 3 6 or 3 9 - 6
• Fisher effect Exact
• r (R - i) / (1 i)
• 2.83 (9-6) / (1.06)

8
Figure 5.4 Interest, Inflation and Real Rates of
Return