(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 202

CHAPTER 5 • 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.