The correlation between financial risk and return is fairly simple to comprehend. The risk in choosing a certain investment is directly proportional to the returns. Therefore, selecting a high-risk investment can give higher profits, while a low-risk investment will minimize the returns.
What are the concerns of all investors?
What is risk free investment?
What would happen if there was a high demand for a risk free investment?
Why is a stock worthless?
What is volatility in debt market?
Is investment A or B risk free?
Is a higher high or lower low riskier?
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What is the relationship between financial decision making and risk & return would all financial managers view risk/return trade offs similarly?
Every decision in finances is key as it affects the overall performance of a company. Risk/return trade offs is concept in finance that is used to show the relationship between the risk and return. Risk and return are positively related. The higher the risk the higher the return.
What is the relationship between risks and returns cite an example?
Generally, the higher the potential return of an investment, the higher the risk. There is no guarantee that you will actually get a higher return by accepting more risk. Diversification enables you to reduce the risk of your portfolio without sacrificing potential returns.
What is the relationship between risk and expected return?
Risk simply means that the future actual return may vary from the expected return. If an investor undertakes a risky investment he needs to receive a return greater than the risk-free rate in order to compensate him. The more risky the investment the greater the compensation required.
Why is there a relationship between rate of return and risk?
To put it simply, risk and the required rate of return are directly related by the simple fact that as risk increases, the required rate of return increases. When risk decreases, the required rate of return decreases.
How the financial decision making involves risk/return trade off?
The risk-return tradeoff states that the potential return rises with an increase in risk. Using this principle, individuals associate low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high potential returns.
Which statement is true of the relationship between risk and return?
Which statement is true of the relationship between risk and return? The greater the risk, the greater the potential return.
What is the difference between risk and return in finance?
Risk takes into account that your investment could suffer a loss, while return is the amount of money that you can make above your initial investment. In an efficient marketplace, a higher risk investment will need to offer greater returns to offset the chances of loss.
What is the relationship between return and risk quizlet?
The relationship between risk and required rate of return is known as the risk-return relationship. It is a positive relationship because the more risk assumed, the higher the required rate of return most people will demand. Risk aversion explains the positive risk-return relationship.
Is there a linear relationship between risk and return?
The CAPM contends that the systematic risk-return relationship is positive (the higher the risk the higher the return) and linear. If we use our common sense, we probably agree that the risk-return relationship should be positive.
Is the relationship between expected return and risk negative?
Negative relationship between risk and return is implicated by the prospect theory. It has been concluded by results of this study that when whole data set is tested as one unit, risk and return of below target return firms are negatively correlated.
What type of relationship exists between risk and expected return quizlet?
There is a positive relationship between risk and return. Total risk is measured by the standard deviation.
Does higher risk mean higher expected return?
High-risk investments may offer the chance of higher returns than other investments might produce, but they put your money at higher risk. This means that if things go well, high-risk investments can produce high returns. But if things go badly, you could lose all of the money you invested.
Is the relationship between risk and return negative?
According to standard finance, risk and return are positively correlated, but many studies conducted in the behavioral finance and prospect theory context have revealed that risk and return are not positively correlated, but are negatively correlated.
Relationship between risk and return when investing - Trading.info
Options & other derivatives. Finally, you can also actively trade options and derivatives.With both, you can achieve enormous returns (sometimes hundreds of percentages on one investment). However, derivatives also involve higher risks. This is because you often use leverage with derivatives. When a stock rises a few percent in value, you can quickly gain or lose tens of percent.
Risk vs. Return: How They Affect Your Investments -SmartAsset
How Risk and Return Are Defined. The level of risk that investors take on is determined by how much money they could lose on their original investment. Risk can refer to both the possibility of a loss and the magnitude of that loss. For example, when an investor calls a particular investment “high-risk,” they might mean that there is a good chance you will lose money, that there is some ...
What is shareholder wealth?
of shareholder wealth, i.e., maximization of the market value of the firm's common stock. Many things affect stock prices, so identifying which changes in stock price are due to management decisions and which changes are due to external factors such as the state of the economy may be difficult. There may also be uncertainty about the eventual financial pay-off of certain business investments. Managers and investors may have different time horizons and different risk preferences, which can affect their
What is a sole proprietorship?
A sole proprietorship is a business owned by a single individual who maintains complete title to the assets and is also personally liable for all indebtedness incurred.
What is the liability of a partnership?
b. In a partnership, all general partners have unlimited liability. Each partner is liable for the actions of the other partners. The partnership agreement dictates the basic relationships among the partners within the firm. As with the sole proprietorship, the
What is a corporation?
c. A corporation is a legal entity functioning separate and apart from its owners. It can individually sue and be sued, purchase, sell, or own property, and be subject to criminal
What happens if people hear about donations?
If people who hear about the donations buy more products in the future, the expenditure today may lead to increased revenue and profit in the future.
Is shareholder wealth maximization a long-run goal?
No . The goal of shareholder wealth maximization must be viewed as a long-run goal. As such, the public image of the firm may be of concern inasmuch as it may
Which is better, a corporation or a partnership?
However, because of certain circumstances, the owners may prefer that ownership not be easily transferred, in which case the partnership would be the most desirable.
What is agency problem?
Agency problems occur when the interests of managers do not align with the interests of shareholders. Maximization of shareholders wealth cannot occur when managers are acting in their own interests. Define, Sole proprietorship, partnership and corporation. Sole Proprietorship: a business owned by a single individual who maintains complete title ...
What is an efficient market?
An efficient market is one that is highly responsive to changes in environment and performance of a company. This means that security prices reflect all publicly available information at any given time. This means that firms can implement their goal of maximizing shareholders wealth by making decisions that keep stock prices high.
What are some examples of firms that involve themselves in projects that do not result directly in profits?
For example, Apple, which we featured in the chapter introduction, donated 50 million to Stanford university hospitals and another 50 mil to the African aid organization (Product)Red, a charity fighting against AIDS, tuberculosis and malaria . Do these projects contradict the goal of maximization of shareholder wealth? Why or Why not?
What is continuous market?
A) A continuous market. This means a series of continuous security prices is generated reducing price volatility and enhancing liquidity
Why do investors demand higher rates of return?
Investors include "inflation premium." within their investment. As the expected rate of inflation increases, investors will demand a higher rate of return (a higher inflation premium) to compensate for the potential loss of purchasing power.
What is the money market?
The money market consists of over-the-counter short term debt instruments (Maturities less than 1 year) such as treasury bills and commercial paper. The capital market deals in long term securities (Maturity greater than one year). The Capital market includes both debt and equity securities and can take place in organized markets or over-the-counter.
What are some examples of over the counter bonds?
Life insurance companies and pension funds are typical examples. These institutions deal in large quantities (blocks) of securities. An over-the-counter bond dealer can easily bring together a few buyers and sellers of these large quantities of bonds. By comparison, common stocks are owned by millions of investors.
What are the concerns of all investors?
There are two primary concerns for all investors: the rate of return they can expect on their investments and the risk involved with that investment. While investors would love to have an investment that is both low risk and high return, the general rule is that there is a more or less direct trade-off between financial risk and financial return.
What is risk free investment?
A risk-free investment is an investment that has a guaranteed rate of return, with no fluctuations and no chance of default. In reality, there is no such thing as a completely risk-free investment, but it is a useful tool to understand the relationship between financial risk and financial return. According to basic concepts of market economics, there would be such a high demand for a risk-free investment that the institution owning the assets underlying the investment would set the rate of return to something essentially equal to the time value of that investment. In other words, if you invested in a risk-free investment, your return would essentially be based entirely on the value of having money now as opposed to some point in the future. That is why interest rates on savings accounts are so low. These are virtually risk-free investments.
What would happen if there was a high demand for a risk free investment?
According to basic concepts of market economics, there would be such a high demand for a risk-free investment that the institution owning the assets underlying the investment would set the rate of return to something essentially equal to the time value of that investment. In other words, if you invested in a risk-free investment, ...
Why is a stock worthless?
This is because the value of a stock is determined by market forces that cause the stock to increase or decrease in value over time. This is known as volatility.
What is volatility in debt market?
Volatility. In the debt market context, investors are primarily faced with two scenarios: they will be compensated at the promised rate of return, no more and no less; or they will lose all of their investment. With stock investments, the possibilities of returns are virtually infinite.
Is investment A or B risk free?
Investment A is risk-free, and Investment B has a 50 percent chance of being completely worthless in five years. Obviously, if these two investments promised the same rate of return, no rational investor would choose Investment B. Instead, there has to be some kind of incentive to choose this riskier investment.
Is a higher high or lower low riskier?
This is known as volatility. A stock with higher highs and lower lows is more volatile, and therefore riskier. However, because this stock has higher highs, it has a higher potential rate of return. Advertisement.
