Question

1. Discuss the concept of risk and return. As a potential investor, where do you think you fall on the conservative to aggressive spectrum, and how does that tie into risk and return?

Answer 1

Ans:

Return:

The outcome or benefit that an investment generates are called return. Value of investment depends on the benefits generated by investment. So value of investment is nothing but present value of future cash flows (returns). Sincce future is uncertain, returns are associated with some degree of uncertainity, which we call as risk.

Risk:

Making investment to get some return on it. However the future is uncertain expected future returns to uncertain. Best examples for this is Covid 19 situation. During Covid 19 situation most of the investments are giving very less return or negative return. So returns are associated with future events. That dependence is called risk.

If we invest in a project, there are two possibilities relating to return

1. Positive return

2. Negative return

For negative return the investor won't be satisfied. Eventhough positive return some times investor won't be satisfied due to expected return grater than actual return. This expected return depends on risk taken by them for investing in that project. This expected return may vary from person to person. For example the expected return on govt. bond is low when compared to a corporate bonds. Because in corporate bonds risk portion is more when compared to govt. bonds. However, how much return an investor wants for taking risk depends on the magnitude of his risk aversion.
Broadly we can classify the investors into 2 types:
1. Conservative
2. Aggressive

For taking a given level of risk, the conservative investor wants more return while the aggressive investor wants less return. The reason for the difference is the magnitude of their risk aversion.

Aggressive investors will take more risk when compared to Conservative type investors for the same level of return.