Risk and Return and Historic Risk Premium

97. Shawn earned an average return of 14.6 percent on his investments over the past 20 years while the S&P 500, a measure of the overall market, only returned an average of 13.9 percent. Explain how this can occur if the stock market is efficient. An investor can purchase securities that have a higher level of risk than the overall market. In an efficient market, these securities will earn a higher return over the long-term as compensation for the assumption of the increased risk. This is the first lesson of the capital markets: There is a reward for bearing risk. Feedback: Refer to section 12.3 AACSB: Reflective thinking Blooms: Analyze Difficulty: 2 Medium Learning Objective: 12-02 The historical returns on various important types of investments. Learning Objective: 12-03 The historical risks on various important types of investments. Section: 12.3 Topic: Risk and return 98. You want to invest in an index fund which directly correlates to the overall U.S. stock market. How can you determine if the market risk premium you are expecting to earn is reasonable for the long-term? You could compare your expectation to the historical market risk premium for the United States, as well as other industrialized countries, realizing of course, that the future will not be exactly like the past. Nevertheless, this should indicate whether or not your expectation is at least reasonable. Feedback: Refer to section 12.4 AACSB: Reflective thinking Blooms: Analyze Difficulty: 2 Medium Learning Objective: 12-03 The historical risks on various important types of investments. Section: 12.4 Topic: Historical risk premium