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CHAPTER • Uncertainty and Consumer Behavior 177 The monetary flow that one receives from asset ownership can take the form of an explicit payment, such as the rental income from an apartment building: Every month, the landlord receives rent checks from the tenants Another form of explicit payment is the dividend on shares of common stock: Every three months, the owner of a share of General Motors stock receives a quarterly dividend payment But sometimes the monetary flow from ownership of an asset is implicit: It takes the form of an increase or decrease in the price or value of the asset An increase in the value of an asset is a capital gain; a decrease is a capital loss For example, as the population of a city grows, the value of an apartment building may increase The owner of the building will then earn a capital gain beyond the rental income The capital gain is unrealized until the building is sold because no money is actually received until then There is, however, an implicit monetary flow because the building could be sold at any time The monetary flow from owning General Motors stock is also partly implicit The price of the stock changes from day to day, and each time it does, owners gain or lose Risky and Riskless Assets A risky asset provides a monetary flow that is at least in part random In other words, the monetary flow is not known with certainty in advance A share of General Motors stock is an obvious example of a risky asset: You cannot know whether the price of the stock will rise or fall over time, nor can you even be sure that the company will continue to pay the same (or any) dividend per share Although people often associate risk with the stock market, most other assets are also risky An apartment building is one example You cannot know how much land values will rise or fall, whether the building will be fully rented all the time, or even whether the tenants will pay their rents promptly Corporate bonds are another example—the issuing corporation could go bankrupt and fail to pay bond owners their interest and principal Even long-term U.S government bonds that mature in 10 or 20 years are risky Although it is highly unlikely that the federal government will go bankrupt, the rate of inflation could unexpectedly increase and make future interest payments and the eventual repayment of principal worth less in real terms, thereby reducing the value of the bonds In contrast, a riskless (or risk-free) asset pays a monetary flow that is known with certainty Short-term U.S government bonds—called Treasury bills—are riskless, or almost riskless Because they mature in a few months, there is very little risk from an unexpected increase in the rate of inflation You can also be reasonably confident that the U.S government will not default on the bond (i.e., refuse to pay back the holder when the bond comes due) Other examples of riskless or almost riskless assets include passbook savings accounts and shortterm certificates of deposit • risky asset Asset that provides an uncertain flow of money or services to its owner • riskless (or risk-free) asset Asset that provides a flow of money or services that is known with certainty Asset Returns People buy and hold assets because of the monetary flows they provide To compare assets with each other, it helps to think of this monetary flow relative to an asset’s price or value The return on an asset is the total monetary flow it yields—including capital gains or losses—as a fraction of its price For example, a bond worth $1000 today that pays out $100 this year (and every year) has a return of • return Total monetary flow of an asset as a fraction of its price
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