Chapter 9 Risk and return 5 Returns that have been adjusted to reflect inflation are called real return The difference between nominal return and real return is important and bears repeating Your nominal return on an investment is the percentage change in the number of dollars you have. Your real return on an investment is the percentage change in how much you can buy with your dollars, in other words, the percentage change in your buying power The fisher effect The fisher effect is the relationship between nominal returns, the real returns, and inflation
Chapter 9 Risk and return Returns that have been adjusted to reflect inflation are called real return. The difference between nominal return and real return is important and bears repeating: Your nominal return on an investment is the percentage change in the number of dollars you have. Your real return on an investment is the percentage change in how much you can buy with your dollars, in other words, the percentage change in your buying power. – The fisher effect The fisher effect is the relationship between nominal returns, the real returns, and inflation
Chapter 9 Risk and return 3 Let R stand for the nominal return and r stand for the real return and h stand for the inflation rate (1+R)=(1+r)×(1+h) 9.3 Average returns: the first lesson Calculating average returns Risk premiums Rate of return on government bonds is the risk-free return because the government can always raise taxes to pay its bills A particularly interesting comparison involves the virtually risk-free return on T-bills and the very risky return on common stocks
Chapter 9 Risk and return Let R stand for the nominal return and r stand for the real return and h stand for the inflation rate. (1+R)=(1+r)×(1+h) 9.3 Average returns: the first lesson – Calculating average returns – Risk premiums Rate of return on government bonds is the risk-free return because the government can always raise taxes to pay its bills. A particularly interesting comparison involves the virtually risk-free return on T-bills and the very risky return on common stocks
Chapter 9 Risk and return 3 The difference between these two returns can be interpreted as a measure of the excess return on the average risky asset. We call this the“ excess” return since it is the additional return we earn by moving from a relatively risk-free investment to a risky one. Because it can be interpreted as a reward for bearing risk, we will call it risk premium. Risk premium is the excess return required from an investment in a risky asset over a risk-free investment So the first lesson is on average risky assets earn a risk premium
Chapter 9 Risk and return The difference between these two returns can be interpreted as a measure of the excess return on the average risky asset. We call this the “excess” return since it is the additional return we earn by moving from a relatively risk-free investment to a risky one. Because it can be interpreted as a reward for bearing risk, we will call it risk premium. Risk premium is the excess return required from an investment in a risky asset over a risk-free investment. So the first lesson is on average risky assets earn a risk premium