Risk and Return on Different Assets

Recall from our discussion in Section A of this chapter that assets have different characteristics. The most important characteristics are the rate of return (or interest rate) and the risk.

The fact that some assets have predictable rates of return while others are quite risky leads to the next important characteristic of investments: Risk refers to the variability of the returns on an investment. If I buy a l-year Treasury bond with a 6 percent return, the bond is a risk less investment because I am sure to get my return. On the other hand, if I buy $10,000 of stocks, I am uncertain about their year-end value .

Looking at both return and risk, individuals generally prefer higher return, but they also prefer lower risk because they. This means that they must be rewarded by higher returns to induce them to hold investments with higher risks. We would not be surprised, therefore, to learn that over the long run safe investments like bonds have lower returns than risky investments like stocks.

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