Question

Which of the following has the highest expected return to the

investor?
A) Common Stock.
B) Preferred Stock.
C) Bonds.
D) They all have similar expected returns.
explain

Answer 1

In the context of common stock, preferred stock, and bonds, common stock typically offers the highest expected return, balancing the increased risk with the potential for greater rewards.

Step-by-step explanation:

When looking at common stock, preferred stock, and bonds, it is important to understand that there is a tradeoff between expected return and risk. Over a sustained period of time, common stocks have been observed to have a higher average return compared to bonds, which in turn offer higher returns than savings accounts. This is due to the fact that with higher risk comes the potential for higher returns, as investors must be compensated for taking on additional risk. For instance, the value of common stocks can significantly fluctuate, as seen with the S&P 500's notable rise and fall in consecutive years 2009 and 2008. Bonds, depending on interest rate changes, have less severe fluctuations in value, but still more than a savings account.

Therefore, the investment with the highest expected return, on average, is common stock. It's crucial to note, however, that this higher expected return comes with a higher risk, and returns can be quite volatile year to year.

Answer 2

Common stock has the highest expected return due to its higher risk and potential for significant growth, while bonds and preferred stock offer lower returns with less volatility.

Step-by-step explanation:

The investment with the highest expected return for an investor is typically common stock. This is due to the potential for significant growth in stock values. For instance, the S&P 500 experienced a substantial increase of 26% in 2009, following a decline of 37% in 2008, illustrating the volatility and potential for high returns in the stock market. In contrast, bonds and preferred stock generally offer lower returns with less volatility.

Bonds provide returns based mainly on interest rates and are considered to have a medium level of risk and return. Preferred stock, while it tends to have a fixed dividend, still carries more risk than bonds but usually less than common stocks.

There is a tradeoff between expected return and risk. Therefore, common stocks, being the riskiest investment among the options provided, also have the highest expected return to compensate investors for taking on more risk. Similarly, the lower risk associated with bonds and preferred stock is reflected in their relatively lower expected returns.