Chapter 05 – Risk, Return, and the Historical Record
5-1
CHAPTER FIVE
RISK, RETURN, AND THE HISTORICAL RECORD
CHAPTER OVERVIEW
This chapter includes two major sections. The first section of the chapter describes the major factors
LEARNING OBJECTIVES
After covering the chapter, the students should be able to describe the major factors that influence the
PRESENTATION OF MATERIAL
5.1 Determinants of the Level of Interest Rates
The chapter begins with the list of the major factors that influence interest rates. It introduces the
5.2 Comparing Rates of Return for Different Holding Periods
The formula for developing historical rates of returns on zero-coupon is shown in equation 5.6. The
5.3 Bills and Inflation, 1926-2012
5.4 Risk and Risk Premiums
The formula for calculation of a single holding period rate of return and a sample calculation are
Chapter 05 – Risk, Return, and the Historical Record
5.5 Time Series Analysis of Past Rates of Return
When working with historical data each of the observed holding period returns, they are assumed to have
5.6 The Normal Distribution
The normal distribution is presented in Figure 5.4. When distributions are normal they have a bell shaped
curve that allows complete description of the portfolio by examining the mean and standard deviation.
5.7 Deviations From Normality and Risk Measures
The normal distribution is symmetric and has small probabilities of occurrences in the tails of the
5.8 Historical Returns on Risky Portfolios
The historical record on investments is presented in Figure 5.6. The material presents results for large
5.9 Long Term Investments
When estimating long-term risk premiums, return distributions can be asymmetric with a significant
Figures 5.10 through 5.12 present analysis of simulated returns using the bootstrapping method. Figure
5.10 shows that returns on both large and small stocks depart from the assumption of normal
distributions. Figures 5.11 and 5.12 show that over the long haul, stocks are indeed more risky and that
terminal values can be less than risk-free securities.