Question

In: Finance

The S&P500 Index has an annual return of 11.5% and 18% volatility over the last 80 years. For small cap stocks, it has been 15.6% for return and 21.2% for volatility.

The S&P500 Index has an annual return of 11.5% and 18% volatility over the last 80 years. For small cap stocks, it has been 15.6% for return and 21.2% for volatility. The average of the bond market index over the same period has return of 5.5% and 6.3% volatility. What is the 40-year forecast of range of return for all 3 asset classes? And what is unusual about the lower range for the stock market and the higher range for the bond market?

Solutions

Expert Solution

Considering the return and volatility of last 80 years for S&P 500, small cap and Bond market index, we have created a range of return for next 40 years.

S&P 500 Index - 10% to 13%

Small Cap Index - 13% to 18%

Bond Index - 5% to 6%

Investing in Stock market provides higher return as it comes with higher risk. During the crisis, the fall in Equity Market can wipe off the most of the capital as can be seen in Global Financial crisis during 2008. Therefore the volatility of Stock market is much higher than Bond Market and hence for the investor holding the quality stock for longer time is rewared with higher return. Hence normally and historically, the Stock market outperformed Bond Market in terms of return. Therefore it is unusual that Stock market has lower range of return than Bond Market


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