Chapter 5: Risk, return and the historical record
5.1 Measuring returns over different holding periods
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holding period return = price increase + income/price paid today
effective annual rate is used for interest rate annualized using compound rather than
simple interest. (1+hpr)^x months – 1, or (1+hpr)^1/x year
annual percentage rates are for short-term investments (not compounded)
1 + EAR = (1+apr/n)^n , APR = n * ((1+EAR)^1/n – 1)
5.2 interest rates and inflation rates
Nominal = growth rate of your money e.g., €100 invested at 10% EAR for 2 years = €120.
Real = growth rate of your purchasing power – inflation = rise of cost on goods
The higher the real interest rate = the greater the supply of household savings (people want to
invest when interest rates are high, they don’t want to spend or get loans)
The lower the interest rate, the more businesses will want to invest in capital
5.3 Risk and risk premiums