Chapter 14: Relationships between return Flashcards

1
Q

Return that investors, as a whole, require on any asset class

A

Required return
= required risk-free real rate of return
+ expected inflation
+ risk premium

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2
Q

Expected return can be analysed as…

A

Expected return
= initial income yield
+ expected capital growth

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3
Q

Capital growth occurs due to (2)

A
  • income growth

- change in the initial income yield.

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4
Q

Fairly-priced assets

A

Assets for which the required and expected returns are equal.

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5
Q

Dividend growth on equities

A
  • Over the long term equity dividend growth is expected to be close to growth in GDP, assuming that the proportion of GDP to “capital” remains constant.
  • There is, however, a dilution effect due to:
  • the need for companies to raise new equity capital
    from time to time if dividend yields are high.
  • the extent to which economic growth is generated
    by start-up companies
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6
Q

Growth / yield on conventional bonds

A
  • For fixed-interest stocks there is no income growth.

- The initial yield and the capital value don’t change for a bond held to redemption

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7
Q

Analysis of total returns compared with inflation

A
  • in periods when inflation turns out to be higher than had been expected, real returns from fixed-interest stocks are lower than expected and are poor compared with equities
  • in periods when yields are rising, real returns from fixed-interest stocks are poor.
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8
Q

Real return on index-linked bonds

A
  • The real return on index-linked bonds is known at outset, if they are held to redemption.
  • The real yield is often taken as the benchmark required real yield.for the analysis of expected returns on equities
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9
Q

Returns on cash and relation to inflation

A

Expected to exceed inflation

Except where:

  • inflation is rising rapidly
  • inflation is under-estimated by investors.
  • Short-term real interest rates very low by governments for significant periods.
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10
Q

Index-Linked Bonds Risk Premia

A
  • Default Risk
  • Liquidity Risk
  • Volatility Risk
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11
Q

Why would Government keep real interest rates high for a significant period? (3)

A

Control aggregate demand/economic growth & inflation

  • Encouraging workers/employees to demand wage increases in moderation
  • Attract foreign investment
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