A fundamental concept in finance is the risk versus return concept. The more the risk involved with an investment, the greater will be the required rate of return for that investment. Different investors have different risk tolerance levels. Some investors may choose not to invest in stocks because they do not like the volatility of the stock market. Others may choose more conservative approaches, such as investing in high quality, intermediate-term bonds, because they prefer the reduced volatility of such an investment as compared to the stock market. From 1926 through 2008: Small-company stocks had an arithmetic mean return of 16.4% and a standard deviation of 33%. Large-company stocks had an arithmetic mean return of 11.7% and a standard deviation of 20.6%. Long-term corporate bonds had an arithmetic mean return of 6.2% and a standard deviation of 8.4%. Long-term government bonds had an arithmetic mean return of 6.1% and a standard deviation of 9.4%. Intermediate-term government bonds had an arithmetic mean return of 5.6% and a standard deviation of 5.7%. U.S. Treasury bills had an arithmetic mean return of 3.8% and a standard deviation of 3.1%. Sources: Adapted with permission from Ibbotson, R. G., & Sinquefield, R. A. (2009). Stocks, bonds, bills and inflation yearbookTM. Chicago: Morningstar. Ross, S. A., Westerfield, R. W., & Jaffe, J. (2010). Corporate finance. New York: McGraw-Hill. Historically, large U.S. stocks have produced higher average annual returns than U.S. Treasury bills. However, in some years, such as 2008, the U.S. Treasury bills outperformed large U.S. stocks. Why do you think this happened?
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