Question

High risk should produce high returns. Illustrate this concept with a real-life example of junk bonds that actually generated high returns for investors.  

Answer 1

There is a direct relationship between risk and return and investor should always try to interpret their risk tolerance in advance before investment into particular security and it is always the nature and the capital along with time duration and other factors which will decide the overall risk and return probability of the investors.

This simple relationship between risk and return can be interpreted through investment into junk bonds because junk bonds are those ones which are having a very high probability of being defaulted upon by the company so the companies are luring the investors by paying a very high yield on these bonds so investors are investing into these bonds who are having a very high risk taking approach, as they are taking the risk of losing out on their investment, if the company has defaulted and these junk bonds are maximizing the rate of return of various investors, so it can be said that higher the risk, higher the return, because there will be higher probabilities of Severe turnaround which can generate serious returns.