The chart below gives information for four classes of U.S. securities over the 1

Question

The chart below gives information for four classes of U.S. securities over the 10-year time period from 1900 - 1999. Order the securities from highest average annual return to lowest for this time period. Now rank the securities from highest to lowest based on risk. Is the information consistent with what financial theory tells us? Why or why not?(Please show work for how you got the order)

(Class of Security) (Average Annual Return 1990 - 1999) (Standard Deviation)

Small Stocks 15.87% 29.04%

Large Stocks 18.99% 14.21%

Long-term Government Bonds 9.23% 9.49%

3-Month U.S. Treasury Bills 5.02% 2.98%

Explanation / Answer

Best stock is Large stock because large stock has highest return with low risk.

Stock Avg. Return Avg. Risk Co-efficient of Variation* Small Stock 15.87 29.04 182.99 Large Stock 18.99 14.21 74.83 Long term Govt Bond 9.23 9.49 102.82 3 mth T-bill 5.02 2.98 59.36 * Co-efficient of variation refers to risk as a percentege of return Ranking Highest to lowest Return Ranking Highest to lowest Risk Large Stock 18.99 Small Stock 29.04 Small Stock 15.87 Large Stock 14.21 Long term Govt Bond 9.23 Long term Govt Bond 9.49 3 mth T-bill 5.02 3 mth T-bill 2.98 As we can see we get highest return in Large Stock but risk is lower as compared to small stock. So,we can say Small stock is inefficient.

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