The chart below gives information for four classes of U.S. securities over the 50-year time period from 1950-1999

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?
What will be an ideal response?

Answer: The text reports the following in Section 8.3:

Class of Security Average Annual Return
1950 - 1999 Standard Deviation
Small Stocks 17.10% 29.04%
Large Stocks 14.89% 16.70%
Long-term Government Bonds 5.94% 9.49%
3-Month U.S. Treasury Bills 5.23% 2.98%

The returns over this time period are consistent with what we expect from financial theory in that increased expected return is accompanied by increased risk. Here, we can define risk as the standard deviation or uncertainty of returns. As the table shows, the return and standard deviation of return are directly related. Students should not be required to know the exact values to complete this table; however, they should be aware of the relative levels of risk and return among the various classifications of securities.