Chapter 14: Relationship between returns and asset classes

Question 1

Required return formula

Answer 1

required risk free real rate of return +
expected inflation +
risk premium

Question 2

Expected return formulae

Answer 2

1. Initial income yield + expected capital growth
2. Initial income yield + income growth + impact of changing yield

Question 3

How comparison of required rate of return and expected return can help evaluate whether an asset is cheap or expensive

Answer 3

If expected return is higher than required return, then the asset is considered cheap

Question 4

When are real yield on fixed-interest bonds poor ?

Answer 4

• When inflation turns out to be higher than expected
• When yields are rising - if bond is not held to redemption

Question 5

Consider the chapter heading

Equities

Answer 5

Over the long term, equity dividend growth might be expected to be close to growth in GDP, assuminng that the share in GDP taken up by capital remains constant.

Question 6

Consider the chapter heading

Bonds

Answer 6

Fixed interest bonds
* No income growth
* initial value + capital value change = gross redemption yield, for a bond held to maturity.

Index-linked bonds
* Real return known at outset, if the bond is held to redemption.
* Real yield is taken as a benchmark required real yield for the analysis of expected returns on equities

Question 7

Consider the chapter heading

Cash

Answer 7

Return on cash is expected to exceed inflation except in periods of higher than expected inflation.