Question

update your own comments on "Trade-off between risk and Return"

(long answer)

Answer 1

Risk - Return trade off theory suggests that as the risk in any project, financial and or physical asset increases the required return from that investment also increases. Usually, assets or projects with lower levels of risk are associated with low returns and those with higher levels of risk are associated with high returns. Based on the risk appetite of an individual or a company or any institution they can be classified as risk averse, risk lover or risk neutral. A risk averse investor avoids risky projects or investments; risk lover investor prefers risky projects or investments and a risk neutral investor is indifferent.

Risk Return theory assumes the concerned investor to be a risk averse individual or company. Thus, in order to lure the risk averse investor into taking greater risk, higher returns is required from the investment. So greater the risk, greater the required return. In case of financial instruments equities are the riskiest form of financial investments thus they provide highest returns, on the other hand cash or cash equivalents such as liquid funds, marketable securities provide least risk and hence least returns.

Companies usually have to make important decisions regarding the source of funding especially long term funding. Two major sources of funds are equity and debt. Since equity is a residual claim on the assets of a company, it is most risky for the investors and hence the required return for the investors are high thereby making equity a costlier source of fund than debt, for the companies. Debt however, offers periodic coupons payments at set interest rate and makes a promise to pay back the principal amount, thereby making them cheaper source of funds.

Kindly up vote my answer.