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215
© 2016 Pearson Education, Inc.
Chapter 8
Risk and Return
LEARNING OBJECTIVES (Slides 8-2 & 8-3)
1. Calculate profits and returns on an investment and convert holding period returns to
annual returns.
2. Define risk and explain how uncertainty relates to risk.
3. Appreciate the historical returns of various investment choices.
4. Calculate standard deviations and variances with historical data.
5. Calculate expected returns and variances with conditional returns and probabilities.
6. Interpret the trade-off between risk and return.
7. Understand when and why diversification works at minimizing risk and understand
the difference between systematic and unsystematic risk.
8. Explain beta as a measure of risk in a well-diversified portfolio.
9. Illustrate how the security market line and the capital asset pricing model represent
the two-parameter world of risk and return.
IN A NUTSHELL…
In this chapter, the author discusses various topics related to the risk and return of
financial assets. The measurement of holding period return and its conversion into
annualized rates of return on investments is covered first, followed by the definition of
risk. After providing a bit of perspective on the nature of historical returns characterizing
securities markets, the author explains how standard deviation and variance can be used
to measure historical or ex-post risk. Next, the calculation of expected or ex-ante risk and
return measures is illustrated using a probability distribution framework, along with a
discussion of the tradeoff between risk and return. The advantages of diversification that
can be derived from the formation of portfolios is covered next, followed by the
components of total risk, i.e. systematic and unsystematic risk, and beta, which is the
only relevant measure of risk of a well-diversified portfolio. The chapter ends with
coverage of the security market line, a type of capital asset pricing model, which was
developed as a way of quantifying the relationship between an asset’s risk and return.
LECTURE OUTLINE
8.1 Returns (Slides 8-4 to 8-13)
In order to analyze the performance of an investment it is very important that investors
learn how to measure returns over time. Furthermore, since return and risk are intricately

216 Brooks ◼ Financial Management: Core Concepts, 3e
related, the measurement of return also helps in the understanding of the riskiness of an
investment.
8.1 (A) Dollar Profits and Percentage Returns: Investment performance can be
measured in terms of the profit or loss derived from holding it for a period of time. Some
investments, such as stocks and bonds, provide periodic income in the form of dividends
or interest, in addition to capital gains (or losses) arising from price changes. Thus, a
generic formula for measuring the dollar profit (or loss) on an investment is as follows:
Dollar Profit or Loss = Ending value + Distributions – Original Cost (8.1)
Dollar profits being absolute values do not provide a good gauge of the relative
performance of an investment. In other words, is a $2 profit on a $10 investment just as
good as a $2 profit on a $100 investment? Obviously not! Hence we calculate the rate of
return or percentage return on an investment as follows:
Dollar Profit or Loss
Rateofreturn
OriginalCost
=
Also, since investments can be held for varying periods of time before being disposed off
or closed out, an alternative name for overall performance of an investment is holding
period return (HPR) and is measured in any one of the 3 following methods:
Profit
Cost
HPR= (8.3a)
Endingprice Distributions Beginningprice
Beginningprice
HPR
+ −
= (8.3b)
+
= −
Endingprice Distributions
1
Beginningprice
HPR (8.3c)
Example 1: Calculating dollar and percentage returns
Joe bought some gold coins for $1000 and sold those 4 months later for $1200. Jane on
the other hand bought 100 shares of a stock for $10 and sold those 2 years later for $12
per share after receiving $0.50 per share as dividends for the year. Calculate the dollar
profit and percent return earned by each investor over their respective holding periods.
Joe’s Dollar Profit = Ending value – Original cost
= $1200 – $1000 = $200
Joe’s HPR = Dollar profit/Original cost
= $200/$1000 = 20%
Jane’s Dollar Profit = Ending value + Distributions – Orig. Cost
= $12*100 + $0.50*100 – $10*100
= $1200 + $50 – $1000
=$250
Jane’s HPR = $250/$1000 = 25%

Chapter 8 ◼ Risk and Return 217
8.1 (B) Converting Holding Period Returns to Annual Returns: For meaningful
comparisons of investment performance, in cases of varying holding periods, it is
essential to state HPRs in terms of either simple (annual percentage rate, APR) or
compound annual returns (effective annual rate, EAR) by using the following conversion
formulas:
HPR
Simpleannualreturn or APR
n
= (8.4)
EAR = (1 + HPR)1/n
– 1 (8.5)
Where n is the number of years or proportion of a year that the holding period consists of.
Example 2: Comparing HPRs
Given Joe’s HPR of 20% over 4 months and Jane’s HPR of 25% over 2 years, is it
correct to conclude that Jane’s investment performance was better than that of Joe?
ANSWER: Compute each investor’s APR and EAR and then make the comparison.
Joe’s holding period (n) = 4/12 = .333 years
Joe’s APR = HPR/n = 20%/.333 = 60%
Joe’s EAR = (1 + HPR)1/n
– 1 =(1.20)1/.33
– 1= 72.89%
Jane’s holding period = 2 years
Jane’s APR = HPR/n = 25%/2 = 12.5%
Jane’s EAR = (1 + HPR)1/n
– 1 = (1 .25)1/2
– 1=11.8%
Clearly, on an annual basis, Joe’s investment far outperformed Jane’s investment.
8.1 (C) Extrapolating Holding Period Returns: It is important to remind students that
although the extrapolation of short-term HPRs into APRs and EARs is mathematically
correct, it often tends to be highly unrealistic and practically impossible to achieve,
especially with very short holding periods.
Extrapolation implies earning the same periodic rate over and over again throughout the
relevant number of times per year.
Hence, if the holding period is fairly short, and the HPR fairly high, extrapolation would
lead to huge numbers as shown in Example 3 below.
Example 3: Unrealistic nature of APR and EAR
Let’s say you buy a share of stock for $2 and sell it a week later for $2.50. Calculate your
HPR, APR, and EAR. How realistic are the numbers?
N = 1/52 or 0.01923 of 1 year.
Profit = $2.50 – $2.00 = $0.50
HPR = $0.5/$2.00 = 25%
APR = 25%/0.01923=1300% or 25%*52 weeks = 1300%
EAR = (1 + HPR)52
– 1 =(1.25)52
– 1= 10,947,544.25%
Highly Improbable!

8.2 Risk (Certainty and Uncertainty) (Slide 8-14)
Most investments are such that one is not sure about their performance at a future date. If
an outcome is known with certainty, such as the value of a treasury bill at maturity, it is
considered riskless.
On the other hand, if an investment has a potential for loss, it would be considered risky.
Hence, risk can be defined as a measure of the uncertainty in a set of potential
outcomes for an event in which there is a chance of some loss.
It is important to measure and analyze the risk potential of an investment, so as to make
an informed decision.
8.3 Historical Returns (Slides 8-15 to 8-16)
The data in Table 8.1, and the histograms graphed in Figure 8.1, provide a synopsis of the
historical record of the returns and variability characterizing 3-month treasury bills, long-
term government bonds, large-cap stocks (capitalization > $5 billion) and small-cap.
stocks (capitalization < $5 billion) in the USA.
Small company stocks earned the highest average return (17.10%) over the 5 decades.
However, their annual returns had the greatest variability 29.04%, widest range (103.39%
– (-40.54%)) = 143.93%), and were most spread out.
In contrast, 3-month treasury bills earned the lowest average return, 5.23%, but their
returns had very low variability (2.98%), a very small range (14.95% – 0.86% = 15.91%)
and were much closely clustered around the mean.
Thus, the historical evidence is clear. Returns and risk are positively related.
8.4 Variance and Standard
Deviation as a Measure of Risk (Slides 8-17 to 8-24)
In statistics, measures of dispersion such as variance and standard deviation can help a
researcher determine how spread out or clustered together a set of numbers or outcomes
is around their mean or average value. The larger the variance, the greater is the
variability and hence the riskiness of the set of values. Equations 8.6 and 8.7 (shown
below) can be used to measure variance and standard deviation.
( )
( )
2
2
average
variance = =
1
i
X
X
n

−
−
 8.6
Where Xi is the return of the asset in period i and n is the number of observations in the
distribution.
2
standard deviation variance  
= = = 8.6
Note: Students often mistakenly state the variance measure in percentage terms,
while it is actually a squared value. The standard deviation, due to being the square
root of the variance, is to be stated in percentage units.

Example 4: Calculating the variance of returns for large-company stocks
Listed below are the annual returns associated with the large-company stock portfolio
from 1990 – 1999. Calculate the variance and standard deviation of the returns.
Year Return
(R –
Mean) (R-Mean)2
1990 -3.20% -22.19% 0.0492396
1991 30.66% 11.67% 0.0136189
1992 7.71% -11.28% 0.0127238
1993 9.87% -9.12% 0.0083174
1994 1.29% -17.70% 0.031329
1995 37.71% 18.72% 0.0350438
1996 23.07% 4.08% 0.0016646
1997 33.17% 14.18% 0.0201072
1998 28.58% 9.59% 0.0091968
1999 21.04% 2.05% 0.0004203
Total 189.90% .18166156
Average 18.99%
Variance 0.020184618
Stand. Dev 14.207%
( )
2
R Mean 0.18166156
Variance 0.020184618
N 1 10 1
 −
= = =
− −
Standard Deviation = √Variance = √.020184618 = 14.207%
8.4 (A) Normal Distributions:
Figure 8.2 is a standard normal bell-shaped curve with a mean of zero and a standard
deviation of one. If data are normally distributed, it lets the researcher or analyst make
the following inferences regarding the expected values of the data:

1. About 68% of all observations of the data fall within one standard deviation of the
average: the mean plus one or minus one standard deviation (add the 34% on the right
of the mean with a corresponding 34% on the left of the mean).
2. About 95% of all observations of the data fall within two standard deviations of the
mean: the mean plus two or minus two standard deviations.
3. About 99% of all observations of the data fall within three standard deviations of the
mean: the mean plus three or minus three standard deviations.
Thus, if a sample of returns with a mean of 10% and a standard deviation of 12% is
normally distributed we could make the following inferences:
• There is a 68% probability that the return in the forthcoming period will lie
between 10% + 12% and 10% – 12% i.e. between -2% and 22%.
• There is a 95% probability that the return will lie between 10% + 24% and
10% – 24% i.e. between -14% and 34%
• There is 99% probability that the return will lie between 10%+36% and 10% -
36% i.e. between -26% and 46%.
These properties imply that financial assets whose returns exhibit smaller variances
would be less risky, since there would be less uncertainty about their future performance.

Table 8.2 and Figure 8.3 (shown above) show that over the past 5 decades (1950-1999),
riskier investment groups have earned higher returns and vice-versa. Thus based on
historical evidence, it can be concluded that the higher the return one expects the greater
would be the risk (variability of return) that one would have to tolerate.
8.5 Returns in an Uncertain World
(Expectations and Probabilities) (Slides 8-25 to 8-28)
When we are contemplating making an investment, it is the expected or ex-ante returns
and risk measures that are more relevant than the ex-post measures that we have covered
so far.
To calculate ex-ante measures the various scenarios with their possible outcomes and
probabilities are estimated, listed in a probability distribution, and then the expected
return and risk measures are estimated using Equation 8.8 and 8.9 (as shown below):
8.5 (A) Determining the Probabilities of All Potential Outcomes. When setting up
probability distributions the following 2 rules must be followed:
1. The sum of the probabilities must always add up to 1.0 or 100%.
2. Each individual probability estimate must be positive. We cannot have a negative
probability value.
Example 5: Expected return and risk measurement
Using the probability distribution shown below, calculate Stock XYZs expected return,
E(r), and standard deviation σ (r).
State of the
Economy
Probability of
Economic State
Return in
Economic State

Recession 45% –10%
Steady 35% 12%
Boom 20% 20%
E(r) = ∑Probability of Economic State × Return in Economic State
= 45% × (-10%) + 35% × (12%) + 20% × (20%)
= -4.5% + 4.2% + 4% = 3.7%
σ2
(r) = ∑[Return in Statei – E(r)]2
× Probability of Statei
= (-10% – 3.7%)2
× 45% + (12% – 3.7%)2
× 35%+(20% – 3.7%)2
× 20%
= 84.4605 +24.1115+53.138 = 161.71
σ (r) = √161.71 = 12.72%
8.6 The Risk-and-Return Trade-off (Slides 8-29 to 8-31)
As described earlier, investments must be analyzed in terms of, both, their return
potential as well as their riskiness or variability.
When faced with investment options having varying risk-return profiles, it is important to
keep the following 2 investment rules in mind.
8.6 (A) Investment Rules
Investment rule number 1: If two investments have the same expected return and
different levels of risk, the investment with the lower risk is preferred.
Investment rule number 2: If two investments have the same level of risk and different
expected returns, the investment with the higher expected return is preferred.
Since investors aim to maximize return and minimize risk, it is obvious that an
investment with both a higher expected return and lower level of risk is preferred over
another asset.
Typically though, if one asset has a higher expected return than another asset, it also has a
higher risk estimate. It is in such cases that the choice is not that clear cut and an
investor’s tolerance for and attitude towards risk matters.
Following the principle of diversification or “spreading out” of risk by holding a portfolio
of assets, rather than just one or two securities, would serve investors well in a world
fraught with uncertainty and risk.
8.7 Diversification: Minimizing
Risk or Uncertainty (Slides 8-32 to 8-43)
Diversification is the spreading of wealth over a variety of investment opportunities so as
to eliminate some risk.
By dividing up one’s investments across many relatively low-correlated assets,
companies, industries, and countries, it is possible to considerably reduce one’s exposure
to risk.

Table 8.4 presents a probability distribution of the conditional returns of two firms, Zig
and Zag, along with those of a 50-50 portfolio of the two companies.
The Portfolio’s expected return, E(rp), return can be measured in 2 ways.
1. E(rp) = Weight in Zig * E(rZIG) + Weight in Zag*E(rZAG) = 0.50 × 15% + 0.50 ×
15% = 15%
OR
2. (a) First calculate the state-dependent returns for the portfolio (Rps) as follows:
Rps = Weight in Zig* R ZIG,S + Weight in Zag* R ZAG,S
Portfolio return in Boom economy = .5 × 25% + .5 × 5% = 15%
Portfolio return in Steady economy = .5 × 17%+.5 × 13% = 15%
Portfolio return in Recession economy = .5 × 5% + .5 × 25% = 15%
(b) Then, calculate the Portfolio’s expected return using Equation 8.8 as follows:
E(rp) = ∑Probability of Economic State × Portfolio Return in Economic State
= .2 × (15%) + .5 × (15%) + .3 × (15%)
= 3% + 7.5% + 4.5% = 15%
The portfolio’s expected variance and standard deviation can be measured by using the
following equations:
σ2
(rp) = ∑[(Return in Statei – E(rp)) 2
× Probability of Statei]
= [(15% – 15%)2
× .20 + (15% – 15%)2
× 50%+(15% – 15%)2
× 30%
= 0 + 0 + 0 = 0
σ (rp) = √0 = 0%
Note: Remind students that the squared differences are multiplied by the probability of
the economic state and then added across all economic states.
8.7 (A) When Diversification Works:
The benefits of diversification are best realized by combining stocks that are not perfectly
positively correlated with each other.
The more negatively correlated a stock is with the other stocks in an investment portfolio,
the greater will be the reduction in risk achieved by adding it to the portfolio.
Table 5 presents a probability distribution of returns for 2 stocks, i.e. The Zig Co., and
The Peat Co., and for an equally-weighted portfolio of the two stocks as well.

Using the data from Table 8.5 we get the following risk-return measures
Zig Peat 50-50 Portfolio
E(r) 12.5% 10.70% 11.60%
Std. Dev. 15.6% 10.00% 12.44%
Figure 8.10 plots the risk- return profiles of the 3 investments and illustrates the
diversification benefit derived from combining these 2 stocks into a portfolio.
The portfolio has an expected return that is equivalent to the weighted average returns of
the 2 stocks, but its standard deviation or risk (12.44%) is lower than the weighted
average of the 2 standard deviations (12.8%).
The portfolio’s risk-return combination plots above the line joining the risk-return
combinations of the two stocks, indicating that the portfolio’s expected return is higher
than what would have been expected based on the weighted average risk of the two
stocks.
8.7 (B) Adding More Stocks to the Portfolio: Systematic and Unsystematic Risk
The total risk of an investment can be broken down into two parts: unsystematic or
diversifiable risk and systematic or non-diversifiable risk.
Unsystematic risk or company-specific risk can be diversified away by efficient portfolio
formation and diversification into investments that have low correlation with each other.
Examples include product problems, labor problems, etc. that plague individual
companies or sectors.

Systematic risk or market risk is non-diversifiable risk in that it permeates through-out the
system and affects everyone, albeit some more than others. For example, recession or
inflation.
A Well-diversified portfolio is one whose unsystematic risk has been completely
eliminated. For example, large mutual fund companies.
Figure 8.11 depicts the breakdown of total risk into its two components , i.e. systematic
risk and unsystematic risk and shows how as the number of stocks in a portfolio
approaches around 25, almost all of the unsystematic risk is eliminated, leaving behind
only systematic risk.
8.8 Beta: The Measure of Risk
in a Well-Diversified Portfolio (Slides 8-44 to 8-47)
Beta is a statistical measure of the volatility of an individual security compared with the
market as a whole. It is the relative tendency of a security’s returns to respond to overall
market fluctuations.
The average beta is 1.0, and a stock with a beta of 1.0 is said to have the same level of
risk as that of the market in general.
Securities with a beta less than 1.0 are considered less risky than the average stock and
the market in general, for example, utility stocks.
Securities with a beta greater than 1.0 are considered more risky than the average stock
and the market in general, for example technology stocks.
A zero-beta, such as a Treasury bill, is uncorrelated or independent of the market in
general.
Betas are estimated by running a regression of the returns (typically weekly returns)on a
stock (dependent variable) with those on a market index (independent variable), such as
the Standard and Poor’s 500. The slope of the regression line (coefficient of the
independent variable) measures beta or the systematic risk estimate of the stock.
Once individual stock betas are determined, the portfolio beta is easily calculated as the
weighted average by using equation 8.10

Example 6: Calculating a portfolio beta
Jonathan has invested $25,000 in Stock X, $30,000 in stock Y, $45,000 in Stock Z, and
$50,000 in stock K. Stock X’s beta is 1.5, Stock Y’s beta is 1.3, Stock Z’s beta is 0.8, and
stock K’s beta is -0.6. Calculate Jonathan’s portfolio beta.
Stock Investment Weight Beta
X $25,000 0.1667 1.5
Y $30,000 0.2000 1.3
Z $45,000 0.3000 0.8
K $50,000 0.3333 - 0.6
$150,000
Portfolio Beta = 0.1667 × 1.5 + 0.20 × 1.3 + 0.30 × 0.8 + 0.3333 × -0.6
=0.25005 + 0.26 + 0.24 + -0.19998 = 0.55007
We have introduced two different measures of risk related to financial assets; standard
deviation (or variance) and beta.
The standard deviation is a measure of the total risk of an asset, both its systematic and
unsystematic risk.
Beta is a measure of an asset’s systematic risk. When we view any one of our assets as
part of a well-diversified portfolio, it is proper to use beta as the measure of risk for the
asset.
If we do not have a well-diversified portfolio, it is more prudent to use standard deviation
as the measure of risk for our asset.
8.9 The Capital Asset Pricing
Model and the Security Market Line (Slides 8-48 to 8-60)
The Security Market Line, shown below in Figure 8.12, is a graphical depiction of the
relationship between an asset’s required rate of return and its systematic risk measure, i.e.
beta. It is based on 3 assumptions.
Assumption 1: There is a basic reward for waiting: the risk-free rate. This means that an
investor could earn the risk-free rate by delaying consumption.
Assumption 2: The greater the risk, the greater the expected reward. Investors expect to
be proportionately compensated for bearing risk.
Assumption 3: There is a consistent trade-off between risk and reward at all levels of
risk. As risk doubles, so does the required rate of return, and vice-versa.
These three assumptions imply that the SML is upward sloping, has a constant slope
(linear), and has the risk-free rate as its Y-intercept.

8.9 (A) The Capital Asset Pricing Model (CAPM): is the equation form of the SML and is
used to quantify the relationship between the expected rate of return and the systematic
risk of individual securities as well as portfolios.
It states that the expected return of an investment is a function of
1. The time value of money (the reward for waiting)
2. A reward for taking on risk
3. The amount of risk
The equation representing the CAPM (Equation 8.11 as shown below) is in effect a
straight line equation of the form:
y a b x
= + 
Where, y is the value of the function, a is the intercept of the function, b is the slope of
the line, and × is the value of the random variable on the x-axis.
By substituting expected return E(ri) for the y variable, the risk-free rate rf for the
intercept a, the market risk premium, (E(rm)-rf) for the slope b, and the systematic risk
measure, β, for the random variable on the x-axis, we have the formal equation for the
SML.
Note: Students often assume that beta is the slope of the SML. Emphasize the point
that the slope of the SML is the market risk premium i.e. (E(rm) – rf) and not beta,
which is on the X-axis. If investors demand a higher risk premium to bear average
risk, the slope of the SML will increase and vice-versa.
Example 7: Finding expected returns for a company with known beta
The New Ideas Corporation’s recent strategic moves have resulted in its beta going from
0.8 to 1.2. If the risk-free rate is currently at 4% and the market risk premium is being
estimated at 7%, calculate its expected rate of return.
Using the CAPM equation we have:

Where;
Rf = 4%; E(rm) –rf =7%; and β = 1.2
Expected rate of return = 4% + 7% × 1.2 = 4% + 8.4 = 12.4%
Note: Students often forget their rules of operation. Remind them to first multiply
7% × 1.2 =8.4; and then add 4% = 12.4%.
8.9 (B) Application of the SML
Although the SML was primarily developed as a way of explaining the relationship
between an asset’s expected return and risk, it has many practical applications. Some
such applications include:
1) To determine the prevailing market or average risk premium, given the expected
returns of a couple of stocks and their betas
Example 8: Determining the market risk premium
Stocks × and Y seem to be selling at their equilibrium values as per the opinions of the
majority of analysts. If Stock × has a beta of 1.5 and an expected return of 14.5%, and
Stock Y has a beta of 0.8 and an expected return of 9.6% calculate the prevailing market
risk premium and the risk-free rate.
Since the market risk premium is the slope of the SML i.e. [E(rm) – rf] we can solve for it
as follows:
Where ∆Y is the change in expected return = 14.5% – 9.6% = 4.9%, and
∆X is the change in beta = 1.5-0.8 = 0.7
So, slope of the SML = 4.9%/0.7 = 7% = [E(rm) – rf]
To calculate the risk-free rate we use the SML equation by plugging in the expected rate
for any of the stocks along with its beta and the market risk premium of 7% and solve.
Using Stock X’s information we have:
14.5% = rf + 7% × 1.5 ➔rf = 14.5- 10.5 = 4%
2) To determine the investment attractiveness of stocks given their betas and expected
return (based on analysts’ forecasts)
Example 9: Assessing market attractiveness
Let’s say that you are looking at investing in 2 stocks A and B. A has a beta of 1.3 and
based on your best estimates is expected to have a return of 15%, B has a beta of 0.9 and

is expected to earn 9%. If the risk-free rate is currently 4% and the expected return on the
market is 11%, determine whether these stocks are worth investing in.
Using the SML we have
Stock A’s expected return = 4% + (11% – 4%) × 1.3 = 13.1%
Stock B’s expected return = 4% + (11% – 4%) × 0.9 = 10.3%
So, Stock A would plot above the SML, since 15%>13.1% and would be considered
undervalued, while stock B would plot below the SML (9%<10.3%) and would be
considered overvalued.
3) To determine portfolio allocation weights and expected return given a desired
portfolio beta and individual stock betas.
Example 10: Calculating portfolio expected return and allocation using 2 stocks
Andrew has decided that given the current economic conditions he wants to have a
portfolio with a beta of 0.9, and is considering Stock R with a beta of 1.3 and Stock S
with a beta of 0.7 as the only 2 candidates for inclusion. If the risk-free rate is 4% and the
market risk premium is 7%, what will his portfolio’s expected return be and how should
he allocate his money among the two stocks?
Determine portfolio expected return using the SML
= 4% + 7% × 0.9 = 4%+6.3%=10.3%
Next, using the two stock betas and the desired portfolio beta, infer the allocation weights
as follows: Let Stock R’s weight = X%; Stock S’s weight = (1-X)%.
Portfolio Beta = 0.9 = X% × 1.3 + (1 – X)% × 0.7=1.3X+0.7 – 0.7X ➔0.6X+0.7 ➔0.9
=0.6X+0.7 ➔ 0.2=0.6X ➔ × = 0.2/0.6 = 1/3➔ 1 – X = 2/3
To check: 1/3 × 1.3 + 2/3 × 0.7 = 0.4333+0.4667 = 0.9 = Portfolio Beta
Questions
1. What are the two parameters for selecting investments in the finance world?
How do investors try to get the most out of their investment with regard to these
two parameters?
The two parameters are risk and return. Investors try to maximize return and minimize
risk.
2. What are the two ways to measure performance in the finance world?
Two ways to measure performance are dollar profits and percentage return.

3. Why is it not practical to convert holding period returns from very short periods
to annual returns?
Extrapolating small period returns to a much longer period requires that the
investment is reinvested in all subsequent periods for the same return. This is often
not attainable.
4. How do we define risk?
Risk can be defined in terms of uncertainty. Uncertainty is the absence of exact
knowledge about an outcome prior to the event.
5. What type of investment has had the highest return on average and the largest
variance from 1950–1999? How much has this investment varied over that fifty-
year period?
From the table in the text Small Company Stocks had the highest average annual
return and the highest standard deviation. This investment has varied, on average, by
about 29.04% per year from its mean over the 50-year period from 1950-1999.
6. What is one of the problems in dealing with an event that has a large number of
potential outcomes?
An event with a large number of potential outcomes requires that each outcome be
assigned a probability. The greater the number of potential outcomes the more
probabilities that must be assigned which usually will be more difficult as the
outcomes increase.
7. What are the two investment rules and how do they influence choices when
considering a pair of potential investments?
Investment rule #1 says that given two assets with identical returns, you select the one
with the least amount of risk. Investment rule #2 says that given two investments with
the same amount of risk, you select the one with the higher return.
8. Why might two different investors select two different potential investments if
one investment had the highest return and the highest risk over the other
investment?
Each investor has his or her own tolerance for risk. So one investor may be more risk
averse than another investor and select a lower risk investment versus someone with a
higher tolerance for risk.
9. What does it mean to diversify your portfolio, and what are you trying to gain by
so doing?
Diversification is a means to lower risk without giving up substantial return for that
level of risk reduction. By selecting a series of investments over a small number of
investments the portfolio provides a better return for that level of risk than individual
assets.
10. What is a positive correlation between two assets’ returns? What is a negative
correlation between two assets’ returns? Which correlation is better for
reducing the variance of a portfolio made up of two assets?
A positive correlation is when two random variables (investments) move in the same
direction when an underlying feature (the economy) changes. A negative correlation

is when two random variables move in opposite directions when an underlying factor
changes. For portfolio diversification, a negative correlation offers more risk
reduction.
11. What is the difference between unsystematic and systematic risk? Which risk
can you avoid? Which risk can you not avoid?
Unsystematic risk is firm specific risk while systematic risk is risk that varies with
changes in the economy. You can avoid unsystematic risk by diversification. You
cannot avoid systematic risk.
12. What is beta in the financial world? What is standard deviation in the financial
world? What type of risk does each measure? What assumption do you make
about the stock when you use beta as a measure of its risk?
Beta is the systematic risk of an asset in a well-diversified portfolio or a well-
diversified portfolio’s total risk measure. Standard deviation is the total risk of an
asset. Beta measures systematic risk, standard deviation measures both systematic risk
and unsystematic risk. When using beta for an individual stock you assume the stock
is part of a well-diversified portfolio.
Prepping for Exams
1.a.
2.b.
3.d.
4.a.
5.b.
6.d.
7.d.
8.a.
9.c.
10.b.
Problems
1. Profits. What are the profits on the following investments?
Investment
Original
Cost or
Invested $
Selling Price
of
Investment
Distributions
Received $ Dollar Profit
CD $500.00 $540.00 $0.00
Stock $23.00 $34.00 $2.00
Bond $1,040.00 $980.00 $80.00
Bike $400.00 $220.00 $0.00

ANSWER
Investment
Original Cost
or Invested $
Selling Price
of
Investment
Distributions
Received $ Dollar Profit
CD $500.00 $540.00 $0.00 $40
Stock $23.00 $34.00 $2.00 $13
Bond $1,040.00 $980.00 $80.00 $20
Bike $400.00 $220.00 $0.00 -$180
CD Dollar Return = $540 + $0 – $500 = $40
Stock Dollar Return = $34 + $2 – $23 = $13
Bond Dollar Return = $980 + $80 – $1,040 = $20
Bike Dollar Return = $220 + $0 – $400 = -$180
2. Profits. What are the profits on the following investments?
Investment
Original Cost
or Invested $
Selling Price
of Investment
Distributions
Received $ Dollar Profits
CD $500.00 $525.00 $0.00
Stock $34.00 $26.00 $2.00
Bond $955.00 $1000.00 $240.00
Car $42,000.00 $3,220.00 $0.00
ANSWER
Investment
Original Cost
or Invested $
Selling Price
of Investment
Distributions
Received $ Dollar Profits
CD $500.00 $525.00 $0.00 $25
Stock $34.00 $26.00 $2.00 -$6
Bond $955.00 $1000.00 $240.00 $285
Car $42,000.00 $3,220.00 $0.00 -$38,780
CD Dollar Return = $525 + $0 – $500 = $25
Stock Dollar Return = $26 + $2 – $34 = -$6
Bond Dollar Return = $1,000 + $240 – $955 = $285
Car Dollar Return = $3,220 + $0 – $42,000 = -$38,780
3. Returns. What are the returns on the following investments?

Investment
Original Cost
or Invested $
Selling Price
of Investment
Distributions
Received $
Percent
Return
CD $500.00 $540.00 $0.00
Stock $23.00 $34.00 $2.00
Bond $1,040.00 $980.00 $80.00
Bike $400.00 $220.00 $0.00
ANSWER
Investment
Original Cost
or Invested $
Selling Price
of Investment
Distributions
Received $
Percent
Return
CD $500.00 $540.00 $0.00 8.00%
Stock $23.00 $34.00 $2.00 56.52%
Bond $1,040.00 $980.00 $80.00 1.92%
Bike $400.00 $220.00 $0.00 -45.00%
CD Percent Return = ($540 + $0 – $500) / $500 = 0.0500 or 8.00%
Stock Percent Return = ($34 + $2 – $23) / $23 = 0.565217 or 56.52%
Bond Percent Return = ($980 + $80 – $1040) / $1040 = 0.01923 or 1.92%
Bike Percent Return = ($220 + $0 – $400) / $400 = -0.45 or -45%
4. Returns. What are the returns on the following investments?
Investment
Original Cost
or Invested $
Selling Price
of Investment
Distributions
Received $
Percent
Return
CD $500.00 $525.00 $0.00
Stock $34.00 $26.00 $2.00
Bond $955.00 $1000.00 $240.00
Car $42,000.00 $3,220.00 $0.00
ANSWER
Investment
Original Cost
or Invested $
Selling Price
of Investment
Distributions
Received $
Percent
Return
CD $500.00 $525.00 $0.00 5.00%
Stock $34.00 $26.00 $2.00 -17.65%
Bond $955.00 $1000.00 $240.00 29.84%
Car $42,000.00 $3,220.00 $0.00 -92.33%

CD Percent Return = ($525 + $0 – $500) / $500 = 0.0500 or 5.00%
Stock Percent Return = ($26 + $2 – $34) / $34 = -0.1765 or -17.65%
Bond Percent Return = ($1,000 + $240 – $955) / $955 = 0.2984 or 29.84%
Car Percent Return = ($3,220 + $0 – $42,000) / $42,000 = -0.9233 or -92.33%
5. Holding period and annual (investment) returns. Baker Baseball Cards Inc.
originally purchased the rookie card of Hammerin’ Hank Aaron for $35.00. After
holding the card for five years, Baker auctioned off the card for $180.00. What are the
holding period return and the annual return on this investment?
ANSWER
Holding Period Return = ($180 – $35) / $35 = 4.1429 or 414.29%
Annual Percentage return= HPR/n = 414.29%/5=82.86%
EAR = (1 + 4.1429)1/5
– 1 = 1.3875 – 1 = 0.3875 or 38.75%
OR
Using a financial calculator:
PV= -35; FV = 180; N = 5; PMT = 0; I = 38.75% ==>
6. Holding Period and Annual (Investment) Returns. Bohenick Classic Automobiles
restores and rebuilds old classic cars. The company purchased and restored a classic
1957 Thunderbird convertible six years ago for $8,500. Today at auction, the car sold
for $50,000. What are the holding period return and the annual return on this
investment?
ANSWER
Holding Period Return = ($50,000 – $8,500) / $8,500 = 4.8824 or 488.24%
APR = HPR/n = 488.24%/6 = 81.37%
EAR = (1 + 4.8824)1/6
– 1 = 1.3436 – 1 = 0.3436 or 34.36%
7. Comparison of returns. Looking back at Problems 5 and 6, which investment had the
higher holding period return? Which had the higher annual return?
ANSWER
Holding Period Return for Trading Card = ($180 – $35) / $35 = 4.1429 or 414.29%
Holding Period Return for Classic Car = ($50,000 – $8,500) / $8,500 = 4.8824 or
488.24%
Trading Card HPR < Classic Car HPR
Trading Card APR = HPR/n = 414.29%/5 = 82.86%
Classic Car APR = HPR/n = 488.24%/6 = 81.37%

Trading Card APR > Classic Car APR➔82.86%>81.37%
Trading Card EAR = (1 + 4.1429)1/5
– 1 = 1.3875 – 1 = 0.3875 or
38.75%
Classic Car Annual Return = (1 + 4.8824)1/6
– 1 = 1.3436 – 1 = 0.3436 or
34.36%
Trading Card EAR > Classic Car EAR.
8. Comparison of returns. WG Investors are looking at three different investment
opportunities. Investment One is a five-year investment with a cost of $125 and a
promised payout of $250 at maturity. Investment Two is a seven-year investment
with a cost of $125 and a promised payout of $350. Investment Three is a ten-year
investment with a cost of $125 and a promised payout of $550. WG Investors can
only take on one of the three investments. Assuming all three investment
opportunities have the same level of risk, calculate the annual return for each
investment and select the best investment choice.
ANSWER
Holding Period Return for Investment One = ($250 – $125) / $125 = 1.00 or 100.00%
EAR-- Investment One = (1 + 1.00)1/5
– 1 = 1.1487 – 1 = 0.1487 or 14.87%
Holding Period Return for Investment Two = ($350 – $125) / $125 = 1.80 or 180.00%
EAR-- Investment Two = (1 + 1.80)1/7
– 1 = 1.1585 – 1 = 0.1585 or 15.85%
Holding Period Return for Investment Three= ($550 – $125) / $125 = 3.40 or 340.00%
EAR-- Investment Three = (1 + 3.40)1/10
– 1 = 1.15969 – 1 = 0.15967 or 15.97%
Investment Three has the highest annual return rate of the three choices. If all choices
have the same level of risk, choose Investment Three.
9. Historical returns. Calculate the average return of -U.S. Treasury bills, long-term
government bonds, and large company stocks for 1990–1999 from Table 8.1. Which
had the highest and which had the lowest return?
ANSWER
Average Return U.S. Treasury Bill for 90s: 5.02%
Average Return U.S. Long-Term Government Bonds for 90s: 9.23%
Average Return U.S. Large Company Stocks for 90s: 18.99%
Highest was Large Company Stocks, Lowest was 3 Month T-Bills
10. Historical returns. Calculate the average return of the U.S. Treasury bills, long-term
government bonds, and large company stocks for the 1950 to 1959, 1960 to 1969,
1970 to 1979, and 1980 to 1989 from Table 8.1. Which had the highest return? Which
had the lowest return?

ANSWER
Answer from data is:
Highest Return was 20.94% in the 50s for Large Company Stocks and the lowest return
was 0.35% for Long-Term Government Bonds in the 50s.
11. Standard deviation. Calculate the standard deviation of the U.S. Treasury bills, long-
term government bonds, and large company stocks for 1990 to 1999 from Table 8.1.
Which had the highest variance? Which had the lowest variance?
ANSWER
U.S. Treasury Bills (1990–1999)
Year Return
(R –
Average) (R – Average)2
1990 7.86% 2.84% 0.00080429
1991 5.65% 0.63% 3.9188E–05
1992 3.54% –1.48% 0.00022023
1993 2.97% –2.05% 0.00042189
1994 3.91% –1.11% 0.0001241
1995 5.58% 0.56% 3.0914E–05
1996 5.50% 0.48% 2.2658E–05

Year Return
(R –
Average) (R – Average)2
1997 5.32% 0.30% 8.7616E–06
1998 5.11% 0.09% 7.396E–07
1999 4.80% –0.22% 5.0176E–06
Total 50.24% 0.00167778
Average 5.02%
Variance 0.000186 =.00167778/(10 – 1)
Std.
Dev. 1.37% =(.000186)1/2
Long-Term Government Bonds (1990–1999)
Year Return (R – Mean) (R – Mean)2
1990 7.13% –2.10% 0.000442
1991 18.39% 9.16% 0.008385
1992 7.79% –1.44% 0.000208
1993 15.48% 6.25% 0.003903
1994 –7.18% –16.41% 0.026939
1995 31.67% 22.44% 0.050342
1996 –0.81% –10.04% 0.010086
1997 15.08% 5.85% 0.003419
1998 13.52% 4.29% 0.001838
1999 –8.74% –17.97% 0.032303
Total 92.33% 0.137864
Mean 9.23%
Variance 0.015318 =.137864/(10 – 1)
Std.
Dev. 12.38% =(.015318)1/2

U.S. Large Company Stocks
Year Return (R – Mean)
(R –
Mean)2
1990 –3.20% –22.19% 0.04924
1991 30.66% 11.67% 0.013619
1992 7.71% –11.28% 0.012724
1993 9.87% –9.12% 0.008317
1994 1.29% –17.70% 0.031329
1995 37.71% 18.72% 0.035044
1996 23.07% 4.08% 0.001665
1997 33.17% 14.18% 0.020107
1998 28.58% 9.59% 0.009197
1999 21.04% 2.05% 0.00042
Total 189.90% 0.181662
Mean 18.99%
Variance 0.020185 =.181662/(10-1)
Std.
Dev. 14.21% =(.020185)1/2
Variance of U.S. Treasury Bills Returns for 90s➔ .000186 (Lowest)
Variance of U.S. Long-Term Government Bond Returns for 90s➔ 0.015318
Variance of U.S. Large Company Stocks Returns for 90s➔ .020185 (Highest)
12. Variance and standard deviation. Calculate the variance and standard deviation of
the U.S. Treasury bills, long-term government bonds, and small-company stocks for
the 1950 to 1959, 1960 to 1969, 1970 to 1979, and 1980 to 1989 from Table 8.1.
Which had the highest variance? Which had the lowest variance?

ANSWER
1950s
Year T-Bills
L-T Gov.
Bonds Large Stocks
Small Co.
Stocks
1950 1.20% –0.96% 32.68% 48.45%
1951 1.49% –1.95% 23.47% 9.41%
1952 1.66% 1.93% 18.91% 6.36%
1953 1.82% 3.83% –1.74% –5.66%
1954 0.86% 4.88% 52.55% 65.13%
1955 1.57% –1.34% 31.44% 21.84%
1956 2.46% –5.12% 6.45% 3.82%
1957 3.14% 9.46% –11.14% –15.03%
1958 1.54% –3.71% 43.78% 70.63%
1959 2.95% –3.55% 12.95% 17.82%
Average 1.87% 0.35% 20.94% 22.28%
Var 0.000055 0.0021066 0.03996 0.086793
Std.Dev 0.74% 4.59% 19.99% 29.46%
Standard Deviation for U.S. Treasury Bill for 50s: 0.74%; Variance=.000055
Standard Deviation for U.S. Long-Term Government Bonds for 50s: 4.59%
Standard Deviation for U.S. Small Company Stocks for 50s: 29.46%
1960s
Year T-Bills L-T Gov. Bonds
Large
Stocks
Small Co.
Stocks
1960 2.66% 13.78% 0.19% -5.16%
1961 2.13% 0.19% 27.63% 30.48%
1962 2.72% 6.81% -8.79% -16.41%
1963 3.12% -0.49% 22.63% 12.20%
1964 3.54% 4.51% 16.67% 18.75%
1965 3.94% -0.27% 12.50% 37.67%
1966 4.77% 3.70% -10.25% -8.08%
1967 4.24% -7.41% 24.11% 103.39%
1968 5.24% -1.20% 11.00% 50.61%
1969 6.59% -6.52% -8.33% -32.27%
Average 3.90% 1.31% 8.74% 19.12%
Var 0.000186 0.003915 0.021117 0.153854
Std.Dev 1.36% 6.26% 14.53% 39.22%

Standard Deviation for U.S. Treasury Bill for 60s: 1.36%
1970s
Year T-Bills
L-T Gov.
Bonds Large Stocks
Small Co.
Stocks
1970 6.50% 12.69% 4.10% –16.54%
1971 4.34% 17.47% 14.17% 18.44%
1972 3.81% 5.55% 19.14% –0.62%
1973 6.91% 1.40% –14.75% –40.54%
1974 7.93% 5.53% –26.40% –29.74%
1975 5.80% 8.50% 37.26% 69.54%
1976 5.06% 11.07% 23.98% 54.81%
1977 5.10% 0.90% –7.26% 22.02%
1978 7.15% –4.16% 6.50% 22.29%
1979 10.45% 9.02% 18.77% 43.99%
Average 6.31% 6.80% 7.55% 14.37%
Var 0.000381 0.0040207 0.037099 0.131502
Std.Dev 1.95% 6.34% 19.26% 36.26%

1980s
Year T-Bills
L-T Gov.
Bonds Large Stocks
Small Co.
Stocks
1980 11.57% 13.17% 32.48% 35.34%
1981 14.95% 3.61% –4.98% 7.79%
1982 10.71% 6.52% 22.09% 27.44%
1983 8.85% –0.53% 22.37% 34.49%
1984 10.02% 15.29% 6.46% –14.02%
1985 7.83% 32.68% 32.00% 28.21%
1986 6.18% 23.96% 18.40% 3.40%
1987 5.50% –2.65% 5.34% –13.95%
1988 6.44% 8.40% 16.86% 21.72%
1989 8.32% 19.49% 31.34% 8.37%
Average 9.04% 11.99% 18.24% 13.88%
Var 0.0008 0.0124889 0.016021 0.034069
Std.Dev 2.88% 11.18% 12.66% 18.46%
Highest variance was 0.153854 in the 60s for Small Company Stocks and the lowest
variance was .000055 for 3 month T-Bills in the 50s.

13. Internet exercise. Find the thirteen-week Treasury bill rates for the years 2000 to
present. Go to Treasury Direct (www.treasurydirect.gov) and in the “Institutions”
section, click “Find Historical Auction Data.” Select the thirteen-week Treasury bill
historical data from January 1, 2000, to present. Record the first auction of each year
from 2000 to present using the investment rate. What was the average from 2000 to
present? What was the standard deviation of this sample of auction rates? How does it
compare with the data presented in Table 8.1?
ANSWER:
Note: We used data for the period January 1, 2000 – January 1, 2011.
The following investment rates come from the first auction of each year:
Year T-Bill rate
(R –
Avg) (R – Avg)2
2000 5.53% 2.19% 0.000478
2001 5.86% 2.53% 0.000638
2002 1.74% –1.60% 0.000256
2003 1.21% –2.13% 0.000454
2004 0.90% –2.44% 0.000594
2005 2.32% –1.02% 0.000104
2006 4.17% 0.83% 6.9E-05
2007 5.06% 1.72% 0.000297
2008 3.26% –0.08% 6.33E-07
2009 1.52% –1.31% .00017161
2010 0.81% –2.02% 4.0804E-4
2011 1.52% –1.31% .00017161
Total 33.9%
Average 2.83%
Variance 0.000352
S.Dev 1.88% =(.000352)1/2
These investment rates are lower than the prior decade i.e 1990s (Average = 5.02%) and
the 50 year history of the Treasury Bill (Average = 5.23%) and closer to the rates of the
1960s (Average = 3.9%).
14. Internet exercise. Find the Standard & Poor's 500 annual returns for 2000 to the
present. Go to Yahoo! Finance (www.finance.yahoo.com), and in the "Get Quotes"
search field, enter SPY (the ticker symbol for the Standard & Poor's 500
electronically traded fund). Select historical prices and find the year-end prices for the

fund and all dividends from 2000 through the end of the most recent year. Find each
year’s return (remember to add in the dividend distributions for the year). What was
the average annual return? What was the standard deviation? How does it compare
with the data presented in Table 8.1?
ANSWER
Note: We used data for the period 1999 - 2010
Year End Price of SPY (1999-2010) and annual Dividends and annual Return
Price Dividends (annual) Return
1999-- 146.88
2000-- 131.19 1.454 – 9.69%
2001-- 114.30 1.032 –12.09%
2002-- 88.23 1.498 –21.50%
2003-- 111.28 1.630 27.97%
2004-- 120.87 2.197 10.59%
2005-- 124.51 2.149 4.79%
2006-- 141.62 2.446 15.71%
2007-- 146.21 2.701 5.15%
2008-- 90.24 2.721 –36.42%
2009-- 111.44 2.177 25.91%
2010-- 125.75 1.786 14.44%
Average 2.26%
Standard Deviation 20.11%
The early years of the start of this decade had negative returns for three consecutive
years, and 2008 was a terrible year as well. The average return is very low (2.26%), and
below every previous decade of the last fifty years. The standard deviation is higher than
the fifty year standard deviation of large company stocks i.e. 20.11% versus 16.7%.
15. Expected return. Hull Consultants, a famous think tank in the Midwest, has provided
probability estimates for the four potential economic states for the coming year. The
probability of a boom economy is 10%, the probability of a stable growth economy is
15%, the probability of a stagnant economy is 50%, and the probability of a recession
is 25%. Estimate the expected returns on the following individual investments for the
coming year.
INVESTMENT
Forecasted Returns for Each Economy
Boom Stable Growth Stagnant Recession
Stock 25% 12% 4% -12%
Corporate Bond 9% 7% 5% 3%
Government Bond 8% 6% 4% 2%

ANSWER
Expected Return on Stock = 0.10 × 0.25 + 0.15 × 0.12 + 0.50 × 0.04 + 0.25 ×
(-0.12)
= 0.0250 + 0.0180 + 0.0200 – 0.0300 = 0.0330 or
3.3%
Expected Return on Corp. Bond = 0.10 × 0.09 + 0.15 × 0.07 + 0.50 × 0.05 + 0.25 ×
.03
= 0.0090 + 0.0105 + 0.0250 + 0.0075 = 0.0520 or
5.2%
Expected Return Gov. Bond = 0.10 × 0.08 + 0.15 × 0.06 + 0.50 × 0.04 + 0.25 ×
0.02
= 0.0080 + 0.0090 + 0.0200 + 0.0050 = 0.0420 or
4.2%
16. Variance and standard deviation (expected). Using the data from Problem 15,
calculate the variance and standard deviation of the three investments, stock,
corporate bond, and government bond. If the estimates for both the probabilities of
the economy and the returns in each state of the economy are correct, which
investment would you choose, considering both risk and return? Why?
ANSWER
Variance of Stock = 0.10 × (0.25 – 0.033)2
+ 0.15 × (0.12 – 0.033)2
+
0.50 × (0.04 – 0.033)2
+ 0.25 × (-0.12 – 0.033)2
= 0.10 × 0.0471 + 0.15 × 0.0076 + 0.50 × 0.0000 +
0.25 × 0.0234
= 0.0047 + 0.0011 + 0.0000 + 0.0059 = 0.0117
Standard Deviation of Stock = (0.0117)1/2
= 0.1083 or 10.83%
Variance of Corp. Bond = 0.10 × (0.09 – 0.052)2
+ 0.15 × (0.07 – 0.052)2
+
0.50 × (0.05 – 0.052)2
+ 0.25 × (0.03 – 0.052)2
= 0.10 × 0.0014 + 0.15 × 0.0003 + 0.50 × 0.0000 +
0.25 × 0.0005
= 0.0001 + 0.0000 + 0.0000 + 0.0001 = 0.000316
Standard Deviation of Corp. Bond = (0.0004)1/2
= 0.01776 or 1.78%
Variance of Gov. Bond = 0.10 × (0.08 – 0.042)2
+ 0.15 × (0.06 – 0.042)2
+
0.50 × (0.04 – 0.042)2
+ 0.25 × (0.02 – 0.042)2
= 0.10 × 0.0014 + 0.15 × 0.0003 + 0.50 × 0.0000 +
0.25 × 0.0005
= 0.0001 + 0.0000 + 0.0000 + 0.0001 = 0.000316
Standard Deviation of Gov. Bond = (0.000316)1/2
= 0.01776 or 1.78%
The best choice is the corporate bond. First, comparing the corporate bond and the stock,
the corporate bond has a higher expected return and a lower variance (standard
deviation). Second comparing the corporate bond and the government bond the corporate

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Tim. The fact is that my girl is very weak, very delicate, a sensitive plant.
Her poor chest troubles her with least thing; and if Lazarus were to lead my
poor Carmen the life which you have led your wife, I should renounce the
relationship and the honour which you propose to me.
Juan. Gently, gently; I have been an irreproachable husband.
Tim. Oh!
Nem. Ah!
Juan. Irreproachable. My wife has always been first in my affections.
Tim. But you have had a second, and a third——
Nem. And a fourth and a fifth.
Juan. Those are lawful requirements of the system of numeration.
Nem. Peace between the future fathers-in-law. The one is as good as the
other; the one is just as gay as the other; and one is quite as sedate a father
of a family as the other.
Juan. And of course you must be better than we are! You who have been
steeped in alcohol from your tenderest years.
Nem. Between the bottle and the woman, I cling to the bottle.
Tim. Well, I to the woman.
Juan. Let us not exaggerate: being between the bottle and the woman
one remains just the same—between the bottle and the woman.
Tim. Not quite: we now remain at home between our own woman and
the bottle of tisan—two tisans.
Nem. Because you are a pair of dotards. I am every night at the theatre,
in my little box: from ten to twelve I consecrate myself to art. Some dancers
have come from Madrid. Sweet zephyrs! Four zephyrs!
Juan (in a loud voice and erecting himself like an old cock). Are they
pretty?
Tim. Your wife will hear you.
Juan (lowering his voice in exaggerated style). Are they pretty?
Nem. Four flowers, four stars, four goddesses, the four cardinal points of
beauty. What eyes! What waists! What vigour! What cushion-like bodies.
Juan. Cushion-like?
Nem. Nothing artificial.

Juan. Nothing artificial? And you are going to the theatre now?
Nem. I go there to finish the night as God commands—in admiring the
marvels of creation. (Rising.)
Tim. Then I’ll accompany you, and we shall both admire them. (Rising.)
Juan. Well, I’ll not stay at home. I’ll go there with you two and we shall
all three admire them. (Rising with difficulty.)
Nem. At this time of night, Juanito?
Juan. You two are going at this time of night.
Tim. And what will your wife say?
Juan. For twenty-five years my wife has said nothing. Besides, I give
orders here. No one ever calls me to account. Ho, there, I’ll be back in a
moment. Ho, there! [Exit.
Nem. I think that poor Juan is getting to the end of his tether. Don’t you
see how he walks? What things he says! What pitiful senilities!
Tim. Yet he is not very old.
Nem. What should make him old? He is little more than sixty. Every man
who respects himself is sixty years old. (Walking about somewhat jauntily.)
Tim. Precisely: you are sixty, I am sixty, every well-conditioned person
is sixty.
Nem. But he has lived! What a life he has lived! This is what I say:
people may be guilty of follies: you have been guilty of them: I have been
guilty of them——
Tim. And every well-behaved person is guilty of them.
Nem. But up to a certain point.
Tim. Up to a certain point.
Nem. But poor Juan was old at forty. And Lazarus is not what his father
says—no, señor.
Tim. Well, talent—he has much talent. All the newspapers of Madrid
assert it; you see it now. That he is a prodigy that he will be a glory to the
nation.
Nem. I don’t deny it. But walk with care before marrying little Carmen to
him.
Tim. Why? The devil! Why? Is he like his father?

Nem. No! Like the father—no. Inclined to gaiety—yes. What would you
have the son of Don Juan to be?
Tim. Everybody is inclined to gaiety. I am so, you are so——
Nem. It is not that. It is that according to my information (lowering his
voice) he is not so robust as the papa supposes. Lazarus suffers from vertigo
—nervous attacks—what shall I say?—something of that sort. At long
intervals, it’s true; but that head of his is not strong. That’s why he does
such stupendous things, and that’s why they call him a genius. Don’t trust
men of genius, Timoteo. A genius goes along the street, and every one says,
“The genius! the genius!” He turns round the corner, and the little boys in
the next street run after him shouting: “The madman! the madman!”
Timoteo, it is very dangerous to have much cleverness.
Tim. God deliver us from it. Oh! as to that I have always been very
careful.
Nem. So have I. A man should not be altogether a fool; that’s not well.
But the thing is—don’t be a genius.
Tim. Never. Here’s Juan coming back.
Nem. Say nothing to him of what I have told you. They either don’t
know of the sufferings of Lazarus, or they hide them; it’s natural.
Tim. Not a word! but it’s well to know it.
Re-enter Don Juan.
Juan (dressed for going out). Are we ready?
Tim. We are.
Juan. Then let’s march. Listen. (To Tim.) Will you come back for
Carmen, or must we take her?
Tim. Carmen?
Juan. Yes, Carmen. Have you already forgotten that she is in there with
Dolores?
Tim. It’s true.
Juan. What a head! Ha, ha! And you say that I——? He forgets his own
daughter! It would have been easy for me to forget my Lazarus. What a
fellow you are! What a fellow you are! Away with you for a pair of
wooden-heads! (Laughing.)
Tim. You gay young dog, lead us on to glory and to pleasure!

Juan. I shall lead you on to the cemetery if you annoy me any more.
However, what do you decide? Will you come back to fetch Carmen?
Tim. I shall have to come back to carry you home.
Juan. You carry me? You’d never be able to carry any one.
Nem. I shall carry you both. Come, give me your arm, Juanito. If not you
can’t go down the staircase. (Don Juan takes his arm.)
Juan. Teresa—little Teresa.
Teresa enters from the back centre.
Ter. Señor?
Juan. Tell Dolores—tell your mistress—that I am going out. Let
Señorita Carmen wait until her father returns to fetch her. March on. (To
Tim.) Take hold of me, for you are not very strong. Take hold of me.
Tim. March on.
Nem. March on.
Juan. Military step! One—two——
Tim. (looking at Teresa). This girl’s prettier every day.
Nem. (the same). And fresher.
Juan (to Nem.). You are not looking; you will fall.
Ter. Where are you going, señor?
Juan. To take these two to the lunatic asylum.
[Exeunt laughing and clutching each other’s arms.
Ter. (looking from the back). Well, when you get in there, may they
never let you out. Where are those mummies going?
Enter Doña Dolores and Carmen from the right.
Car. Ah! They are not here. Papa is not here.
Dol. Have they gone out?
Ter. Yes, señora. But Don Juan left word that Señorita Carmen’s papa
would come back to take her home.
Carmen coughs.
Dol. Coughing again! You ought not to go out at night; the doctor has
forbidden you. You don’t take care of yourself. You are a little simpleton.

Sick children should be in their little homes.
Car. When I am alone I am very sad. I had rather cough than be sad.
Dol. Not so; I shall go and bear you company. And I shall bring
Lazarus. I don’t wish my sick child, my darling child to be melancholy.
(Fondling her.)
Carmen coughs.
Again!
Car. It’s not worth speaking of.
Dol. The fact is that no one can breathe here. What an atmosphere!
What smoke! What a smell of tobacco.
Ter. The three ancient gentlemen were all the night drinking and
smoking and laughing. Now you see how they have left everything.
Dol. Yes, I see. (Looking with disgust at the little table which is full of
ashes and ends of cigars and covered with bottles, glasses, and waiters’
trays.) Take these things away; clean everything up; open the balcony. I am
not accustomed—yet after twenty-five years I should have grown
accustomed. (Aside.) The poetry of existence! (Laughing bitterly.)
Car. What are you laughing at, Dolores?
Dol. (changing her tone and feigning merriment). I feel amused, very
much amused at the frolics of those three venerable old men.
Car. Papa is not yet an old man.
Dol. He is not: but what a life he has led. (Recollecting herself.) So
laborious—his business—his commerce—the same as Juan.
Car. Ah yes. Parents are all alike, killing themselves for their children.
And Papa is very good. He loves me—my God! At night he gets up I don’t
know how many times and listens at the door of my room to know if I am
coughing, so that I, who hear him, stifle the cough with my handkerchief or
with the bed-clothes; but sometimes I am not able—it is that I am choking.
(Coughs.)
Dol. (to Teresa who has been meanwhile taking away bottles, ash-trays,
waiters’ trays, and who has entered and gone out several times). Open the
balcony! Let in the fresh, pure air. No, wait. (To Carmen.) You could not
bear the sensation, my poor little one. Come. (Taking her by the hand.)
Car. Where to?

Dol. While the room is being ventilated you must remain like a quiet
little girl behind this curtain. (Placing her behind the curtain to the right.) A
quiet little girl, eh? Afterwards you shall enter.
Car. (laughing). Are you leaving me in punishment?
Dol. In punishment! Your father is very indulgent, I am very severe.
Car. Good; but your punishment does not last long.
Dol. Not very long. (To Teresa.) Go: I shall open it.
[Exit Teresa.
Dolores opens the balcony.
So! Air—the air of night—space—freshness—that which is pure—that
which is great—that which does not revolt one—that which dilates the
lungs—that which expands the soul! To have a very broad horizon which
one may fill with hopes, and to run towards those hopes! At least hope!
Hope! Oh! I cannot complain. I have my Lazarus—then I have everything.
Car. (putting her head from time to time through the curtain). May I
come out?
Dol. No, not yet; wait—quiet, my little one. (Walking from the balcony
to the fireplace.) To have my son! But without him ever having had a father
—above all, that father! Oh, if my Lazarus had sprung spontaneously from
my love! Even as—as the wave of the sea or the light of the sun springs
forth. After all, let me not complain—even if he resembled—though he
does not resemble—his father, Lazarus is mine and mine only. How good!
How noble. What intellect! What a heart! Oh, what it is to have such a son!
Car. May I come in?
Dol. Ah, yes—wait though—I shall first shut the balcony. (Shuts it.)
Come in.
Car. That’s very different. (Breathing with pleasure.)
Dol. You feel well?
Car. Very well.
Dol. What are you looking at?
Car. The clock—to see what time it is. It is getting late: Lazarus is not
coming. (Sadly.)
Dol. It is not late, my child. Come and sit by me.

Car. Yes, it is late, it is late.
Dol. Lazarus will come soon. He knew that you were coming this
evening, and he will not fail.
Car. (sorrowfully). But he would do wrong to inconvenience himself for
me. If he does not see me now, he’ll see me another day.
Dol. You silly child, are you complaining?
Car. Not at all. My God! He has his engagements, and he must not
sacrifice himself for Carmen.
Dol. Carmen deserves it all; and Carmen knows it; don’t be a little
hypocrite.
Car. No, señora, I speak as I think, and that’s what gives me much pain
and makes me quick at finding fault. You fondle me and love me, as if you
were my own mother, now that I no longer have one. You watch over our
love—the love of Lazarus and myself. I am sure you tell Lazarus that I am
this and that—in short, a prodigy. And you swear to me that Lazarus is mad
for the love of his Carmen. But is all this true? Can it be so? Am I worthy of
Lazarus? Can such a man as he feel the passion which you describe to me
for a poor creature like myself?
Dol. Come, now—I shall get vexed. Don’t say such things. Why, have
you never looked into the glass?
Car. Yes, many times—every day.
Dol. And what does the glass tell you?
Car. That I am very pale, that I am very thin, that I have very sad eyes,
and that I rather resemble a mother of sorrows than a girl of eighteen. That’s
what it tells me, and it causes me a rather unpleasant feeling.
Dol. There are very malevolent mirrors, and yours is one of them. (In a
comic tone.) They take the form of boats to give us long faces; they get
blurred to make us pale; they become stained to sow freckles all over our
skins; and they commit every kind of wickedness. Yours is a criminal
looking-glass; I’ll send you one in which you may see what you are, and
you shall see an angel gazing through a tiny window of crystal.
Car. Yes. (Laughs.) But even if I were the most beautiful woman in the
world, could I be worthy of Lazarus? A man like him! A future such as his!
A talent which all admire. Nay, a superior being. I love him much; but it
makes me afraid and ashamed that he should know that I love him so much.

I feel as if he were going to say to me: “But who are you, you little
simpleton? Have you imagined that I am meant for an unsubstantial,
ignorant, sickly little thing like you?” (Sadly and humbly.)
Dol. Well, Carmen, if you don’t wish to make me angry, you will not
talk such folly. A good woman is worth more than all the learned men of all
the Academies. And if, as well as being good, she is pretty, then—then
there’s an end, there is no man who is worthy of her. Men, with the
exception of Lazarus, are either mean-spirited wretches or heartless devils.
(In a rancorous tone.)
Car. Well, papa is very good, and is very fond of me.
Dol. Ah, yes—a very good person. But, if he had been so fond of you,
he would have done better to give you stronger lungs.
Car. But, poor man, how is he to blame? If God did not wish——
Dol. Ah! yes, that’s true. It is not Don Timoteo’s fault. It was God’s
disposition that Carmen should have no more breathing powers than those
of a little pigeon, and we must be resigned.
Car. Well, that’s what I say. But Lazarus is not coming. You’ll see that I
shall have to go away before he comes. And, if he comes and sets to work, I
shall be as little likely to see him to-night.
Dol. No; he has not written for some days. The excess of work has
fatigued him. This constant thought is very wasting.
Car. But is he ill? (With great anxiety.)
Dol. No, child; fatigue, and nothing more.
Car. Yes; he is ill. I noticed that he was sad, preoccupied, but I thought,
“There, it is that he does not love me, and he does not know how to tell me
so.”
Dol. What things you imagine! Neither the one nor the other. My
Lazarus ill! Do you think that if he had been so I would not have set in
motion all the first medical faculty here, and in Madrid, and in foreign
parts? In any way, however (somewhat uneasily), you are right; he is very
late.
Car. Did he go to the theatre?
Dol. No, to dine with some friends.
Car. Did Javier go?

Dol. He went also.
Car. I am glad; Javier is very sensible.
Dol. So is Lazarus.
Car. I should think so; but a good friend is never superfluous, and Javier
has admiration, affection, and respect for Lazarus.
Dol. (walking about impatiently). Still, it is getting late—very late.
Carmen turns towards the balcony.
What are you going to do?
Car. Well, to watch and see if Lazarus is coming.
Dol. (drawing her away from the balcony). No, child; you don’t think of
your poor chest, nor of that most obstinate cough of yours. Moreover, the
night is very dark, and you could see nothing. Come away, Carmen, come
away; I’ll watch.
Car. If I can’t see, neither will you see——
Dol. I shall try.
Car. Wait; I think he is coming, and with Javier.
Dol. (listening). Yes—it’s true.
Car. Are they not coming in here?
Dol. No; they have gone straight to the room of Lazarus. But don’t be
uneasy; as soon as he knows that you are here, he will come to see you.
Car. Without doubt he comes back thinking of some great scene for his
drama, or of some chapter of that book which he is writing and which they
say is going to be a miracle of genius, or of some very intricate problem.
Ah! my God, whatever you may say, a man such as he cannot concern
himself very much about an insignificant girl like myself.
Dol. Again!
Car. I know nothing, I am worth nothing, I am nothing. I? What am I fit
for? Tell me. To stare at him like a blockhead while he is considering these
great matters; to watch at the balcony and see if he is coming, although it
may be cold, and Carmen coughs incessantly; to weep if he takes no notice
of me, or if they tell me that he is ill. There is no doubt that little Carmen is
capable of doing wonders. To look at him, to wait for him, to weep for him.

Dol. And what more can a woman do for a man? To look at him always,
to wait for him always, to weep for him always.
Car. And is that enough?
Dol. So much the worse for Lazarus if that should not be enough for
him. But wait; he’s here now; did I not tell you? as soon as he knew you
were here.
Car. (joyfully). It’s true. How good he is.
Enter Javier.
Jav. A pleasant evening, Doña Dolores; pleasant evening, Carmen.
Dol. A very good evening.
Car. And a very pleasant—but—Lazarus——
Dol. Is not Lazarus coming?
Car. Is he ill?
Dol. Ah! if he is ill, I must go there——
Jav. (stopping her). No, for God’s sake! What should make him ill?
Listen to me. We and several friends have been dining with two writers
from Madrid—people of our profession. We spoke of arts, of sciences, of
politics, of philosophy, and of everything divine and human. We drank, we
gave toasts, we made speeches, we read verses. You understand? And these
things excite in an extraordinary way the nervous system of Lazarus.
Dol. And has anything gone wrong with him? My God!
Car. Go, Dolores—go!
Jav. For the sake of God in heaven, let me conclude. These things, I say,
shake his nerves, and his imagination becomes on fire; it soon discovers
luminous horizons; the ideas rush upon him precipitately. Could you take
upon yourselves the burden of them? No; that which came with the fever of
inspiration he wished to take advantage of, and for that reason—precisely
for that reason—he locked himself up in his room and sent me away.
Car. (sadly to Dolores). Did I not say so? He would come—and to
work.
Dol. Does he not know that Carmen is here?
Jav. They told us that on our entrance; but he pays attention to nothing, to
nobody, when inspiration and glory and art cry aloud to him, “Come, we are
waiting for you.”

Dol. However—— (Wishing to go.)
Car. No, for God’s sake! (Stopping her.) He must be allowed to work. If
through me he should lose any of those grand ideas which now hover
fondly about him, what pain and what remorse for me! Disturb him that he
may come and speak to me? No, not so; I am not so selfish. I asked for
nothing better. By no means can I consent. (Embraces Dolores; coughs
and almost weeps.)
Dol. (with anxiety). What’s the matter with you?
Car. (affecting merriment). Nothing; it is only that I had begun to laugh
and cough at the same time. I laughed because I was reminded of a tale—a
very silly tale, which made me laugh, however, and which fits the case. You
shall judge. There was a very sprightly little female donkey, which became
enamoured of a most beautiful genius, who bore on his forehead a very red
little flame, and had very white wings; and the bright genius, out of pure
compassion, fondled the ears of the little donkey; and she, in accordance
with her nature, began to leap for joy, and it overthrew the genius, clipped
his wings, and he could fly no more. The blue of the firmament was cut off
from the genius, and there was left to him nothing more than a very green
meadow, a little female donkey who was very good, but who was, after all,
a donkey. No, mother, I don’t wish to be the heroine of the story. Let us
allow the genius to fly.
Dol. (to Javier). See what a creature she is!
Jav. A criminal humility.
Dol. But, indeed, if you persist, we shall let him work.
Car. Don’t you think we might let him have this room free to himself?
Here he has his books of predilection, and he has more room, and he can
walk about; he has told me many times that he composes verses while
walking about.
Dol. A good idea! Let us go to my sitting-room. (To Javier.) Tell him
that we abandoned the field to him, and that he may come without fear.
Jav. (laughing). Noble sacrifice!
Dol. But we’ll have to make up the fire; since we opened the balcony a
while ago the room has become very cold. (Stirring the fire.)
Car. It’s true. But let him not receive the full heat. We must place the
screen in front—so. (Places it.)

Dol. It is well—so.
Car. (going to the balcony and raising the curtain). Look—look! The
sky has become a little cleared, and the moon has issued from the clouds.
Very beautiful! Very beautiful! We must draw the curtain back, that Lazarus
may see it all and be the more inspired. I know he likes to work while
gazing towards the heavens from time to time.
Dol. (running to help Carmen). You are right; you think of everything.
Jav. Well, if after so many precautions and such endearments the
inspiration is not responsive, the inspiration of Lazarus is hard to please.
Car. Is everything ready now?
Dol. I think so. Wait—your portrait is hidden in the shade. We must
place it so that the lamp may throw light on it, so that he may be inspired by
it also.
Car. I inspire him? Yes—yes! Take it away. (Wishing to remove it.)
Dol. I shall not allow it. Let it remain where I have put it, and let us go.
Car. If you insist—well, then let him see it. But there is not much light.
(Turning up the light of the lamp.)
Dol. (to Javier). Call him—let him come.
Car. Yes, let him come and write something very beautiful. Then I shall
enter for a moment, to bid him good-night.
Dol. Until then—come, Carmen.
Car. (to Javier). And you, too, leave him alone; you must not have any
more privileges than we.
Dol. Are you coming to keep us company?
Jav. Later on.
Car. Is everything in order? (Looking round.)
Dol. I think so. Adieu.
Car. Adieu!
[Exeunt to left Carmen and Dolores, half embracing each other.
Jav. The field is clear. Poor women! How they love him! It is adoration.
(Going to right.) Lazarus! Good-for-nothing! Now you can come—come, if
you can!

Enter Lazarus, pale, somewhat in disorder, and with unsteady
step; in short, as the actor may think fit.
Laz. (looking about). Are they not here?
Jav. No; fortunately it occurred to them that you would work better
alone.
Laz. Well, whatever you say, I think that I am presentable. Eh? My head
doesn’t feel bad—a delicious vagueness. I seem to be encircled by a mist—
a very soft mist; and through its texture there shine some little stars. In
short, peaceful sensations, very peaceful.
Jav. That’s to say, you are better?
Laz. Don’t I tell you so? My legs indeed give way, but without pain. I
walk in the midst of softness. (Laughing.) My head among the clouds and
the ground of cotton-wool. Divine! So ought the universe to be—that is,
quilted. Lord! what a world has been made of it—so rough, so hard, so
inconvenient. At every step you stumble and injure yourself—rocks, rugged
stones, sharp points, peaks, angles, and little corners and big corners. The
world should be round—quite so, and round it is; roundness is perfection;
but it should be an immeasurable sphere of eider-down, so that, if a citizen
falls, he may always fall amid softness—thus! (Letting himself fall in the
arm-chair, or on one of the cushioned stools at the side of the table.)
Jav. All very well—but you really are not strong.
Laz. I am not strong? Stronger than you—stronger than you. Stronger.
Jav. I told you that you should not drink. It does you harm; your health is
broken down.
Laz. I’m broken down? I?—How? I have not been a saint, but neither
have I been a madman. I am young: I have always thought that I was
strong: and, through drinking two or three glasses, and smoking a puro and
laughing a little—here am I transformed into a stupid being! Because, now,
it is not that I am broken down, as you say, nor that I am drunk, as you
suppose—it is that I feel simply stupid. No; and see, now, it is not so
disagreeable to be stupid: one feels—a sort of merriment, as it were. That’s
why so many people are merry. (Laughing.) That’s why! That’s why! Now I
am falling into this same stupidity—that’s why, just so.
Jav. Attend to me, and understand what I say to you, if you are in a
condition to understand me.

Laz. If I can understand you? I understand everything now. The world is
transparent to me: your head is made of crystal (laughing), and written in
very black and tortuous letters I read your thought—you suppose I am very
bad. Poor Javier! (Laughing.)
Jav. Don’t talk such rubbish: I neither think such a thing, nor are you
really ill. Fatigue, weariness—nothing more. You have lived very fast in
Madrid during the last few years: you have thought much, you have worked
much, you have had a good deal of pleasure, and you need a few months’
rest—here—in your father’s house, with your mother, with Carmen.
Laz. Carmen—yes—look at her. (Pointing to the photograph.) There she
is. How sad, how poetical, how adorable a countenance. I wish to live for
her. With all the glory that I achieve I shall make a circle of light for that
dear, pretty little head. (Sends a kiss to the portrait.) We shall live together,
you and I, my sweet little Carmen, and we shall be very happy. (As if
speaking with her.) For I wish to live. (Growing excited and turning to
Javier.) If I had never lived it would never have suggested itself to me that I
should continue to live: but I have commenced, and I don’t wish to break
off so soon. No—no—it shall not be—as God lives.
Jav. Come, Lazarus.
Laz. I am strong. Why should I not be so? What right has nature to make
of me a feeble creature when I wish to be strong? My thought burns, my
heart leaps, my veins abound with the exuberance of life, my desires are
aflame! To put steam of a thousand atmospheres into an old and rusty
boiler! Oh! infamous mockery!
Jav. Eh! There you are, started off! What steam, or what boiler? The little
glass of champagne.
Laz. A man like myself cannot be tormented with impunity. Here you
have the world: it is yours: run merrily through its valleys, mount its
summits in triumph! But you shall not run, you shall not mount, unless
rheumatism is planted in your bones. Here you have the azure firmament: it
is yours: fly among its altitudes, gaze upon its horizons. But you shall not
fly except the plumage of your wings be wrenched away and you become a
worm-eaten carcass. What derision! What satire! What cruelty! Accursed
wine! What extravagant things I see, Javier! Colossal figures in masks float
across the firmament, and, hung from very long strings, which are
suspended from very long canes, they bear suns and splendours and stars,

and they sweep onward crying, “Hurrah! hurrah!”[1] and I wish to reach all
that, and I cannot touch even one little star with my lips. Grotesque, very
grotesque! Cruel! very cruel! Sorrowful, very sorrowful! My God! My
God! (He hides his face in his hands.)
Jav. Come, Lazarus, come. You see you cannot commit even the slightest
excess.
Laz. I have uttered many follies, have I not? No matter: no one hears me
but you, and it’s a relief to me. See, now I am more composed. I feel tired,
and I even think I am sleepy.
Jav. That would be best for you: sleep, sleep, and let neither your mother
nor Carmen see you thus.
Laz. As for my mother, it would not matter. (Smiling.). But, Carmen—
let not Carmen see me looking ridiculous. The poor girl who imagines that I
am a superior being! Poor child, what a joke! (Stretches himself on the
sofa.)
Jav. Good; now don’t speak. I shall not speak either; and try to sleep.
With half an hour of sleep everything will pass off.
Laz. Sleep, too, is ridiculous at times. If I am very ridiculous don’t let
Carmen see me.
Jav. No; if you don’t look as beautiful as Endymion she shall not enter.
Pause. Javier walks about. Lazarus begins to sleep.
Laz. Javier, Javier.
Jav. What?
Laz. Now I am—almost asleep. How do I look?
Jav. Very poetical.
Laz. Good—thank—you. Very poetical.
A pause.
Jav. No, Lazarus is not well. I shall speak to his father—no, not to Don
Juan. To his mother, who is the only person of sense in this house.
Laz. Javier.
Jav. What do you want?
Laz. Put Carmen’s picture more to the front.
Jav. So?

Laz. So. For her—the light; for Lazarus—the gloom.
Jav. (walking about slowly). Yes, I shall speak to his mother. And—
happy coincidence! I had not remembered that the celebrated Doctor
Bermudez, a specialist in all that relates to the nervous system, has arrived
within the last few days. Then to him! let them consult with him.
Laz. (now almost asleep). Javier.
Jav. But are you not going to sleep?
Laz. Yes—but more in the light—more in the light. (With a somewhat
sorrowful accent.)
Jav. Come (placing the portrait close to the light)—and silence.
Laz. Yes ... Carmen!...
Jav. (contemplating him for a while.) Thank God—asleep.
Dolores, Carmen, Don Juan, and Timoteo appear at the threshold
of the door at the back centre.
Car. May we come in?
Jav. Silence!
Car. It was to say good-night.
Jav. He is asleep. He worked a short time, but he was fatigued.
Car. Then let us not disturb him. Adieu, Javier. The light is in his eyes—
you should lower the shade. Adieu. (Kissing Dolores.) Adieu, Don Juan.
Tim. (to Dol.) Till to-morrow. (To Don J.) Till to-morrow.
Juan. Nor shall we let to-morrow go by. I shall pay you a solemn visit—
and prepare yourself, little rogue (to Carmen).
Car. I?
Juan. Silence, he is asleep.
Tim. Good, good. Ah! it is late. Good-bye.
Dol. Good-bye, my daughter.
All have spoken in low voices.
[Exeunt Carmen and Timoteo.
Dol. (approaching Javier.) Did he work long?
Jav. A short time, but with great ardour. A great effort of intellect.

Juan (approaching also and contemplating Lazarus). Lord, to think of
what this boy is going to be! The face foretells it. The aureola of talent!
Dol. He is very pale—very pale.
Juan. What would you have him to be? Fat as a German, and red as a
beetroot? Then he would not be a genius.
Dol. However—such pallor!
Juan and Dolores are bent over Lazarus contemplating him with
affectionate care.
Juan. I am decidedly the father of a genius, and then (to Javier) they
come to me with——
Jav. With what?
Juan. With nothing. (Aside.) With moral sermons, and with the law of
heredity, and with all that stale trash. The father a hare-brained fellow, and
the son a wise man.
Dol. But has nothing been amiss with him? Was it nothing more than
fatigue?
Jav. Nothing more. You may withdraw: I shall stay until he awakes.
Juan. I shall not withdraw. I was wanting nothing better. I shall sit down
here (sitting at the other side of the table), and from here I shall watch the
sleep of Lazarus. You remain on foot, in honour of the genius. Keep away,
keep away from before him, that you may not prevent me from seeing my
son.
Dol. Yet the sleep is not very restful.
Juan. How should it be restful, woman, since he must be busied with
great matters in his dreams?
Dol. My Lazarus.
Jav. (aside.) Poor Lazarus.
Juan (laughing quietly). Don Juan Tenorio—watching the sleep—of the
son of Don Juan!—silence—silence—let’s see if we shall hear anything
from the son of Don Juan. (With pride and tenderness.)
END OF ACT I

ACT II.
Same appointments as in first Act. It is day. On the little table are flowers.
Don Juan discovered seated close to the tea-table. Lazarus also
discovered. He sometime walks about; again he sits down: he tries to
write, he throws away the pen. He opens a book and reads for a few
moments, closes it irritably and resumes his walking about. It is evident
that he is uneasy and nervous. All this in the course of the scene with
his father. Don Juan follows him with his eyes and smokes a puro.
Juan. What are you thinking of? Ah! pardon! I must not disturb you.
Laz. You don’t disturb me, father. I was thinking of nothing important.
My imagination was wandering, and I was wandering after it.
Juan. If you wish to work—to write—to read—and I trouble you I shall
go. Ha, I shall go. (Rising.) Do you want me to go? for here I am going.
Laz. No, father, good gracious! You disturb me!
Juan (sitting down again). The fact is, as you see, that which I do can be
done anywhere. It is in substance nothing. Well, for the performance of
nothing any point of space is good. (Laughing.) Of space! There are your
philosophical offshoots taking root in me. The father in space, the son in the
fifth heaven. That’s why I say if I disturb——
Laz. No, father, don’t go away; and let us talk of what you please.
Juan. Much good you’d get by talking with me. To your great books, to
your papers, to those things which astound by their greatness and are
admired for their beauty! Continue—continue! I shall see you at work. I,
too, shall busy myself with something. (Pulls the bell.)
Laz. As you like. [Sits down and writes fitfully.
Enter Teresa.
Juan. Little Teresa—(looking at his son and correcting himself.) Teresa,
bring me a glass of sherry and a few biscuits; I also have to busy myself
with something. And bring me the French newspapers; no, nothing but
Figaro and Gil Blas. (To his son.) And so we shall both be at work. (To

Teresa.) Listen—by the way, bring me that novel which is in my room. You
can read, can’t you?
Ter. Yes, señor.
Juan. Well, then, a book which says Nana—you understand?
Ter. Yes, señor. Ná-ná.—For no is ná.
Juan. It is something, little girl,—(aside) something that you will be in
time. [Exit Teresa.
Laz. (Rises and walks about—aside). I have no ideas. To-day I have no
ideas. Yes, I have many; but they come like a flight of birds; they flutter
about—and they go.
Juan. See now—I cannot bear immoral novels.
Laz. You said ...?
Juan. Nothing! I thought that you said something. I said that I cannot
endure immoral novels. (Assuming airs of austerity.) I read them, I read
“Nana,” out of curiosity, as a study, but I can’t bear them. Literature is in a
lost condition, my son, in a lost condition. Nemesio lent me that book—and
I am anxious to have done with it.
Laz. Zola is a great writer. (Aside.) This is the very thing that I was
looking for. (He sits and writes.)
Enter Teresa with a tray, a bottle of sherry, a glass and the
biscuits, “Nana” and the two newspapers.
Ter. Here is everything. The sherry: the newspapers just come, the
tender little biscuits, and the tender little Nana (baby) as well. (She stands
looking at the two gentlemen.)
Juan. Bring the sherry closer, Teresa.—Work, boy, work. Take no notice
of me. Work, for it is thus that men attain success. I also in my youth have
worked much. That’s the reason I look so old. (Staring at Teresa who
laughs.) (Aside.) What’s that stupid girl laughing at?—(To Teresa.) Now,
you may go. I don’t want you. The Gil Blas! (Unfolds it and begins to read
it.) Let us have a look at these wretched little newspapers.... (affecting
contempt.) I told you to go.—(To Teresa.)—Let’s see, let’s see. (Reads.)
Ter. Yes, señor. (She remains for awhile looking at the two, and turns
towards the door in the back centre.)
Laz. (rising). Teresa—

Ter. Señorito—
Laz. Come here and speak lower: let us not disturb your master, who is
reading. Did you take the letter which I gave you this morning?
Ter. Yes, señorito, I took it myself. Whatever you require me to do,
señorito!...
Laz. Good. It was for Señor Bermudez, eh?
Ter. Yes, señorito. That doctor who has such a great name, who has
come from Madrid for a few days to cure Don Luciano Barranco—the same
who, they say, is either mad or not mad. (Laughing.)
Laz. (starting, then restraining himself). Ah! Yes. Quite so; the same.
And did you see him? Did you hand him the letter? Did he give you the
answer? Where is it? Come, quick!
Ter. Eh, señorito—
Laz. Come—
Ter. I gave the letter: he was not in:—they said—
Laz. Lower—(Looking at his father who laughs while reading the
newspaper.)
Ter. They said that as soon as he came back they would give him the
letter. Have no fear, señorito. Whatever little I take charge of! Well, if I do
nothing worse than—
Laz. It’s well—thanks. (Dismissing her, then recalling her.) Oh! if they
bring the answer—here on the instant—eh?
Ter. On the instant: I should think so! have no fear, señorito.
Laz. Enough! let us not trouble my father.
[Exit Teresa.
Juan. Ha! ha! ha! Facetious, very facetious! sprightly, very sprightly!
Pungent as a capsicum from the Rioja! It is the only newspaper that one can
read!
Laz. Some interesting article? What is it? What does it say? Let me see!
(Approaching and stretching out his hand.)
Juan (keeping back the newspaper). A very shameless little article—and
quite without point. It must be put away. (Puts it in a pocket of his dressing-
gown, but in such a way that it may be seen.) May the devil not so contrive

things that Carmen may come and find the newspaper and read it in all
innocence.
Laz. (withdrawing). It is true: you do well! (Walks about nervously.)
Juan (aside). And I had not finished reading it: I shall read it afterwards.
(Takes up “Nana.”) This also is good. The spring with all its verdure.
(Aloud.) Work, boy, work!
Laz. (aside). I shall speak to the Doctor this very day, that he may set
my mind at ease. I know that nothing is the matter with me; but I want a
specialist to assure me on the point. And then, with mind at peace—to my
drama, to my critico-historical work, to my æsthetic theories which are new,
completely new—and to Carmen. And with the muse at one side,
recounting marvels in my ear, and with Carmen on the other side, pressed
against my heart—to enjoy life, to inhale the odour of triumphs, to live for
love, to satiate my longings amidst eternal mysteries.
Juan. Stupendous! Monumental! Sufficient to make one die of laughing.
Lord, why does a man read? To be amused; then books that are amusing for
me! (Laughing.)
Laz. Is that a nice book?
Juan (changing his tone). Pshaw—yes—pretty well. But these frivolous
things are tiresome after all. (Sees Lazarus coming towards him, and puts
“Nana” into the other pocket of the dressing-gown.) Have you anything
solid to read—really substantial?
Laz. I have many large books. What class do you want?
Juan. Something serious; something that instructs you, that makes you
think.
Laz. (going to the bookcase). Would you like something of Kant?
Juan. Of Kant? Do you say of Kant? Quite so! he was my favourite
author. When I was young I went to sleep every night reading Kant. (Aside.)
What will that be? It sounds like a dog.
Laz. (searching out a passage). If you like, I shall tell you.
Juan. No, my lad; any part whatever! (Taking the book.) Yes, this may
be read at any part. You shall see. And don’t concern yourself with me;
write, my son, write.
Lazarus sits and attempts to write. Don Juan reads.

“Under the aspect of relationship, the third consequence of taste, the
beautiful appears to us as the final form of an object, without representation
of end.” The devil! (holding the book far off, as long-sighted people do and
contemplating it with terror.) The devil! “or as a finality without end.”
Whoever can understand this? “Because what is called final form is the
causality of any conception whatever with relation to the object.” Let me
see—let me see. (Holding the book still further off.) “Final form the
causality.” I believe I am perspiring. (Wipes his forehead.) “The
consciousness of this finality without end is the play of the cognitive
forces.” How does he say that? “The play of the forces—the play.” Well, I
ought to understand this about play. “The consciousness of this internal
causality is that which constitutes the æsthetic pleasure.” If I go on it will
give me a congestion. Jesus, Mary and Joseph! And to think that Lazarus
understands about the finality without end, the causality and the play of the
cognitive forces! God help me! What a boy!—(continues reading.) “The
principle of the formal convenience of nature is the transcendental principle
of the force of Judgment.” (Giving a blow on the table.) I shall be lost if I
continue reading. But if that boy reads these things he will go mad.
Laz. Does it interest you?
Juan. Very much! What depth! (Aside.) For five minutes I have been
falling, and I have not reached the bottom. (Aloud.) I should think it does
interest me! But, frankly, I prefer—
Laz. Hegel?
Juan. Exactly. (Aside)—“Nana.” But you, my son, neither read, nor
write: you are fretful. What’s the matter with you? Did the hunting tire you?
Yet the exercise of the chase is very healthy for one who like you wears
himself away over his books. Are you ill?
Laz. No, señor, I am not ill. And I spent these three days in the country
very pleasantly. But this morning broke dull and rainy, and I said
—“Home!”
Juan. And you arrived when I was getting up. I told you the great news;
immediately you showed great delight; but then you fell into sublime
preoccupations. Poor Carmen! (approaching him with an air of secrecy.)
You don’t love her as she loves you.
Laz. With all my soul! More than you can imagine! I am as I am:
reserved, untamed, unpolished—but I know how to love!

Juan. Better and better! The poor little thing—come, now—the poor
little thing.
Laz. And why did not Don Timoteo answer on the spot that he accepted?
When you asked him for his daughter for me, why did he hesitate?
Juan. What do you mean by hesitation? I do him the honour of
requesting the hand of Carmen for my Lazarus—and he would hesitate! I
should strangle the scarecrow. Marry a man like you! What more could any
daughter or any father desire?
Laz. Then why did he put off the answer till to-day?
Juan. The prescriptions of etiquette: social conventionalities: he was
always a great stickler for etiquette. Because he must consult with Carmen.
Imagine him consulting with Carmen! When the poor little thing is like a
soul in purgatory, and you are her heaven.—Ha! ha!
Laz. You are right.
Juan. No: you shall have your sweet little wife, your home; you shall
work hard, you shall gain great glory, you shall keep a sound judgment—
and let the whole world say: Don Lazarus Mejia, son of Don Juan Mejia!
Oh!
Laz. Yes, señor: I shall do what I can—and I shall love my Carmen
dearly.
Juan. That’s right—that’s right. But something’s the matter with you.
You seem as it were absent-minded.
Laz. I am thinking—of my drama.
Juan. Then I shall go! decidedly I shall go! With my insipid chatter I
prevent you from thinking. Oh! thought! the—the—(looking at the book)
“the cognitive forces”—the—the—(looking again) “the finality”—that’s it
—“the finality.”—Ah!—Good-bye.
Laz. But don’t go away on my account.
Juan. We must show respect to the wise. (Laughing.) I am going to read
all alone the great book which you have lent me. (Taking a flower and
putting it in the buttonhole of his dressing-gown.) Consider now, whether I
shall hesitate between Kant and “Nana.” (Pulls the bell.)
Laz. As you please.
Juan. Good-bye, my son. To your drama—to your drama—and put
nothing immoral in it.

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