Demand for Risky Assets

*  Assets

- Something which provides a flow of money or services to its owner.

-  The flow of money or services can be explicit or implicit .

*  Capital Gain 

- An increase in value of an asset, while the decrease is a capital loss.

*  Risky & Riskless Assets

- Risky Asset 

• Provides uncertain flow of money or services to the owner.
• Examples

- Apartment rent, corporate bonds, capital gains, stock prices

- Riskless Asset

• Provides flow of money or services which is known with certainty.
• Examples

- Short term government bonds, short term certificates of deposit

*  Asset Returns

- Return on an Asset

-  The total monetary flow of asset as fraction of its price.

- Real Return of an Asset

-  The simple return less the rate of inflation.

*  Asset Returns

  Expected versus Actual Returns

- Expected Return

• Return which an asset should earn on average

- Actual Return

• Return which an asset earns

- Higher returns are associated with the greater risk.

- The risk averse investor should balance risk relative to return

* Risk and Budget Line

  Expected return, RP, increases as the risk increases.

 The slope is price of risk or risk-return trade-off.

Choosing Between Risk and Return


The Choices of Two Different Investors