Chapter 22: Relationship between returns on asset classes 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 share of GDP taken by “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.

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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 change for a bond held to redemption yield.

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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.

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9
Q

Returns on cash

A

Expected to exceed inflation

Except where:

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

Set out the components of expected return

A
  • Initial income yield
  • Expected capital growth:
  • — Income growth
  • — Change in Yield
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