McGraw-Hill/Irwin Copyright 2005 by The McGraw-Hill Companies,
Inc. All rights reserved. Chapter 5 History of Interest Rates and
Risk Premiums 5-2 Factors Influencing Rates Supply Households
Demand Businesses Governments Net Supply and/or Demand Federal
Reserve Actions 5-3 Q0Q0 Q1Q1 r0r0 r1r1 Funds Interest Rates Supply
Demand Interest Rates Supply Q0Q0 Q1Q1 r0r0 r1r1 Funds Demand Level
of Interest Rates 5-4 Fisher effect: Approximation nominal rate =
real rate + inflation premium R = r + i or r = R - i Example r =
3%, i = 6% R = 9% = 3% + 6% or 3% = 9% - 6% Fisher effect: Exact r
= (R - i) / (1 + i) 2.83% = (9%-6%) / (1.06) Empirical
Relationship: Inflation and interest rates move closely together
Real vs. Nominal Rates 5-5 HPR = Holding Period Return P 0 =
Beginning price P 1 = Ending price D 1 = Dividend during period one
Rates of Return: Single Period 5-6 Ending Price =48 Beginning Price
= 40 Dividend = 2 HPR = ( )/ (40) = 25% Rates of Return: Single
Period Example 5-7 1) Mean: most likely value 2) Variance or
standard deviation 3) Skewness * If a distribution is approximately
normal, the distribution is described by characteristics 1 and 2.
Characteristics of Probability Distributions 5-8 Symmetric
distribution mean s.d. Normal Distribution 5-9 Subjective returns
p(s) = probability of a state r(s) = return if a state occurs 1 to
s states Mean Scenario or Subjective Returns 5-10 StateProb. of
Stater in State E(r) = (.1)(-.05) + (.2)(.05)...+ (.1)(.35) E(r)
=.15 Scenario or Subjective Returns: Example 5-11 Standard
deviation = [variance] 1/2 Subjective or Scenario Var =[(.1)( ) 2
+(.2)( ) ( ) 2 ] Var= S.D.= [.01199] 1/2 =.1095 Using Our Example :
Variance or Dispersion of Returns 5-12 Table 5.2 History of T-bill
Rates, Inflation and Real Rates for Generations, 5-13 Figure 5.2
Interest Rates and Inflation, 5-14 Geometric Average Returns TV =
Terminal Value of the Investment g= geometric average rate of
return 5-15 Geom.Arith.Stan. SeriesMean%Mean%Dev.% Sm Stk Lg Stk LT
Gov T-Bills Inflation Annual Holding Period Returns (Arithmetic)
5-16 Risk Real SeriesPremiums%Returns% Sm Stk Lg Stk LT Gov T-Bills
Inflation Risk Premiums Real Returns 5-17 Figure 5.6 Histograms of
Rates of Return for 5-18 Table 5.3 History of Rates of Returns of
Asset Classes for Generations, 5-19 Table 5.4 History of Excess
Returns of Asset Classes for Generations, 5-20 Figure 5.7 Nominal
and Real Equity Returns Around the World, 5-21 Figure 5.8 Standard
Deviations of Real Equity and Bond Returns Around the World,
