Investment Clues From the Past ASSET 20 YEARS RETURN RANK 10 YEARS RETURN RANK 5 YEARS RETURN RANK 1 YEAR RETURN RANK Stocks 12 2 1 14 8 1 15 1 1 11 6 2 Bonds 9 8 2 13 2 2 13 1 2 14 8 1 Stamps 9 6 3 (1 7) 11 0 5 11 8 8 4 3 month Treasury bills 8 8 4 7 3 4 6 6 4 3 3 8 Diamonds 8 5 5 5 9 5 4 3 5 1 5 11 Oil 7 5 6 (4 7) 12 1 7 12 (6 3) 12 Gold 6 9 7 (1 0) 9 (4 2) 9 9 6 3 Housing 6 7 8 4 4 7 3 7 7 1 8 10 Consumer Price Index 6 1 9 3 8 8 4 2 8 3 3 7 Chinese ceramics 5 8 10 7 6 3 9 8 3 (7 5) 13 U S farmland 5 4 11 (1 2) 10 2 1 10 2 3 9 Foreign exchange 3 4 12 5 6 6 1 7 6 6 2 6 Silver 2 7 13 (10 1) 13 (8 5) 13 8 4 5 Use this data to answer the following questions (10 points) Suppose you invest $1,000 in each of the assets appearing in the above table in 1973 What is the terminal value of each asset in 1993 The terminal value of your total investment The terminal value in real terms Why may a small difference in reported return amount to a large difference in terminal wealth a (10 points) Discuss each of the five factors favoring financial assets and each of the five factors favoring tangible assets In particular, provide the transmission mechanism through which these shocks affect the stock market b (10 points) Suppose we expect a drop in the inflation rate Would you invest in bonds or stocks Why And if you choose bonds, would you buy long term or short term bonds Explain why (10 points) When the article was written (in 1993), one could have observed the following Inflation rates were very low and were expected to remain sooil prices were especially low Telephone and airline companies slashed prices as a result of increased competition The Cold War era had ended There were regions experiencing political unrest, the probability of a superpower confrontation had declined President Clinton had raised taxes and would do so again The governments role in the economy under President Clintons administration was expected to shrink (5 points) Given these predictions, would you concentrate your investments in financial or tangible assets If financial assets, would you invest in airline and oil stocks or auto manufacturing firms Explain why (5 points) Explain the relationship between the industries selected and the reason given for the decline in inflation expected in the future

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Investment Clues From the Past ASSET 20 YEARS RETURN RANK 10 YEARS RETURN RANK 5 YEARS RETURN RANK 1 YEAR RETURN RANK Stocks 12.2% 1

Investment Clues From the Past

ASSET	20 YEARS RETURN	RANK	10 YEARS RETURN	RANK	5 YEARS RETURN	RANK	1 YEAR RETURN	RANK
Stocks	12.2%	1	14.8%	1	15.1%	1	11.6%	2
Bonds	9.8	2	13.2	2	13.1	2	14.8	1
Stamps	9.6	3	(1.7)	11	0.5	11	8.8	4
3-month Treasury bills	8.8	4	7.3	4	6.6	4	3.3	8
Diamonds	8.5	5	5.9	5	4.3	5	1.5	11
Oil	7.5	6	(4.7)	12	1.7	12	(6.3)	12
Gold	6.9	7	(1.0)	9	(4.2)	9	9.6	3
Housing	6.7	8	4.4	7	3.7	7	1.8	10
Consumer Price Index	6.1	9	3.8	8	4.2	8	3.3	7
Chinese ceramics	5.8	10	7.6	3	9.8	3	(7.5)	13
U.S. farmland	5.4	11	(1.2)	10	2.1	10	2.3	9
Foreign exchange	3.4	12	5.6	6	1.7	6	6.2	6
Silver	2.7	13	(10.1)	13	(8.5)	13	8.4	5

Use this data to answer the following questions:

(10 points) Suppose you invest $1,000 in each of the assets appearing in the above table in 1973. What is the terminal value of each asset in 1993? The terminal value of your total investment? The terminal value in real terms? Why may a small difference in reported return amount to a large difference in terminal wealth?

a. (10 points) Discuss each of the five factors favoring financial assets and each of the five factors favoring tangible assets. In particular, provide the transmission mechanism through which these shocks affect the stock market.

b. (10 points) Suppose we expect a drop in the inflation rate. Would you invest in bonds or stocks? Why? And if you choose bonds, would you buy long-term or short-term bonds? Explain why.

(10 points) When the article was written (in 1993), one could have observed the following:

Inflation rates were very low and were expected to remain sooil prices were especially low. Telephone and airline companies slashed prices as a result of increased competition.

The Cold War era had ended. There were regions experiencing political unrest, the probability of a superpower confrontation had declined.

President Clinton had raised taxes and would do so again.

The governments role in the economy under President Clintons administration was expected to shrink.

(5 points) Given these predictions, would you concentrate your investments in financial or tangible assets? If financial assets, would you invest in airline and oil stocks or auto manufacturing firms? Explain why.