Question

300-400 words, APA Citation/References

What is the relationship between risk and return? What is the significance of this relationship for the investor?

Answer 1

The relationship between risk and return is that as the level of risk increases , the expected return also increases but it could not be the case at all times. As the level of risk decreases , the expected return falls. The returns provided by the Fixed deposits are the least and the return provided by equities is the maximum . This illustrates the fact that , as the level of risk rises the expected return also increases. As the return is not guaranteed by accepting a higher level of risk, diversification helps reduce the risk in a portfolio of securities. Once, our portfolio is fully diversified, we can increase the level of return by accepting a higher level of risk.

As an investor, i would like to invest in the least risky securities like Government bonds and Treasury securities which offer the highest level of safety that is the risk is at the minimum but the return is lowest . These securities are backed by the trust of the Government. These securities provide a lower risk but the returns may not be able to keep pace with the inflation.

As an investor i have a choice to invest either in stocks or bonds. As a stock market investors the shareholders are the owners of the company and they enjoy higher or lower returns depending upon the success of the company. If the company is successful, the shareholders enjoy a higher rate of return and if it is unsuccessful , the investors lose their hard earned money.So, stock investments are riskier.

When we invest in bonds, we are assured of a fixed payment of principal and interest , the risk is lower as the bind holders are assured of the fixed payments due to them and in the case of bankruptcy, they enjoy priority in receiving  payments. They do not enjoy the success of the company, they will be paid the fixed payments even though the company is profiting. The risks are lower but the returns are less than what a shareholder of the company would enjoy.