Question

Describe the relationship between risk and expected reward. Also, explain the advantages and disadvantages of utilizing leverage through margin trading. What is your personal view on using margin trading in an investment portfolio?

Answer 1

Hello Sir/ Mam

1. Relationship between risk and expected reward

The relationship between risk and expected rewards is called Risk-Return Tradeoff. Risk - Return tradeoff states that that the potential rewards increases with increase in risk, i.e. direct relationship.It is quite often said, "More Risk, More Rewards".

2. Advantages of Utilizing Leverage through margin trading:

Through margin trading, we can buy the securities worth more than our ledger balance with the broker. Margin trading exposes us to more rewards. We can earn multiplicated income using margin trading.

Disadvantages of Utilizing Leverage through margin trading:

As we can buy more than our ledger balance, it exposes us to a multiplicated risk as well. A more than normal margin can even expose you to loss of upto 100%. So, it's quite risky. Also, more often than not, it involves an interest cost.

3. My view on the margin trading is consistent with the optimum risk-reward tradeoff. I believe that margin trading provides a good advantage when used in personal risk profile constraints. Margin must not be exposed too much or else we can end up losing everything.

I hope this solves your doubt.

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