Question

Describe the general relation between risk and return that we observe in the historical bond and stock market data.

Answer 1

Risk and return are directly related. Higher the risk, higher the return and lower the risk, lower the return.

Bond historically earn lower return due to their lower risk in comparison to equity or share market. Bond earns fixed income on regular intervals or interest earning is defined during the issuance hence, it has definite cash flows which gives assurance to investors. During liquidation of firm the bond holders are paid before equity and preference shareholders hence, carry lower risk than shareholders.

Share market historically yield higher return as they carry higher risk in comparison to bond market. The income of shareholders is not definite and highly volatile hence, it carries high risk. The shareholders are paid at last during the liquidation of firm hence, it is remains in highest of risk category.