Question

When evaluating the risk preferences discussed in the study material - risk aversion, risk neutrality and risk seeker - which one do you identify with? Does the return increase or decrease with the type of risk with which you identify? Explain.

Define in your words what risk is in the context of financial decision making and performance.
Explain what is the relationship between risk and return.

Answer 1

I identify myself as the risk seeker. I am open to taking risks because my age and financial position allows me to do so. Also I want higher returns on my investment which is not possible without risk. Hence returns are directly proportional to the risk undertaken. Higher the risk higher will be the return.

In the context of financial decision making and performance, risk represents the uncertainty of returns and future conditions. The classic example is that of investment in the stock market. It represents substantial amount of risk as compared to investing in a bank or in bonds. There is no guarantee as to the returns from stock investment. There can be immense profit and there is also a possibility that the entire capital may be wiped out. Hence risk and return are directly proportional to each other.