Final answer:
Return becomes more volatile with increased debt and decreased equity. This volatility stems from the financial risks associated with fixed debt payments during economic downturns and the diluted ownership when using more equity. Economic periods, such as tech booms or recessions, illustrate shifts in confidence and capital demand.
Step-by-step explanation:
Return is more volatile as debt goes up and equity goes down. This is due to the financial leverage effect, where the use of borrowed funds (debt) can amplify the potential returns and risks of an investment. As companies increase their reliance on debt, the variability of their returns—also seen as volatility—tends to rise. This is partly because debt obligations require fixed payments regardless of business performance, increasing the financial strain and risk during downturns. In contrast, equity financing does not come with such compulsory payments, and hence provides a buffer during difficult times but leads to diluted ownership and control over the company.
Historically, different economic periods have illustrated shifts in businesses' behavior toward capital demand. For example, during the technology boom of the late 1990s, businesses were highly optimistic about their return on investments, leading to increased demand for financial capital. However, in the face of the 2008 and 2009 Great Recession, their confidence dwindled, and accordingly, the demand for financial capital at any given interest rate shifted to the left, indicating reduced demand due to higher perceived risk.
On the broader scale of investment, over time, equities tend to offer higher return rates compared to bonds, which in turn offer higher returns than savings accounts. This is due to the inherent volatility in stocks, which can lead to significant growth or decline in value over short periods, as was seen with the S&P 500's dramatic changes in 2008 and 2009.