14. Relationship between returns on asset classes Flashcards
1
Q
What is the relationship between required and expected return
5
A
Required return = required risk-free real rate of return + expected inflation + risk premium
- =>An investor expects that the value of their investment does not decrease in real terms, and that they are compensated for the risk taken
Expected return = initial income yield + expected capital growth
- => Expcted return is what the investor expect to achieve on the asset, given the price paid for the asset, the price for which he/she expectes to sell/redeem the asset , and the expected income whilst the asset is help
Approximation: initial income yield + income growth + impact of change in yield
If Required return = Expected return priced fairly
If Required return < Expected return cheap
2
Q
Expected Return on different asset classes. Equities, Conventional GB, index-linked bonds, property, cash
A
- Equities = Dividend yield + expected nominal dividend growth
- Property = rental yield + expected nominal rental growth
- Index-linked bond = GRY (real)
- Conventional bonds = GRY(nominal)
- Cash = short-term nominal interest rates
3
Q
When will the real returns on conventional bonds be poor?
A
- Inflation turns out to be greater than expected
- Period where yields are rising=> Market price of existing bonds decrease=> real return on these is lower
4
Q
Over the Long Term, What Is Equity Dividend Growth Expected to Be Close To?
A
- Economic growth → GDP
- Assumes that the share of GDP represented by capital remains constant over time
- Dilution effect due to companies raising new capital
1. Depends on how much start-up companies contribute to the economic growth
5
Q
What Factors Affect the Expected Return on Cash?
A
- Returns on cash are expected to be greater than inflation, except when:
- Inflation is rising rapidly
- Inflation is underestimated by investors
* Short-term real interest rates kept high or low for a long period
