Question

Which statement is false regarding risk and return? a. For broad asset classes, the relationship between risk and return is nearly linear.

b. Adding multiple shares to a portfolio can reduce non-systematic risk.

C. There is a nearly linear relationship between risk and return for individual shares.

d. Because investors can easily eliminate risk through diversification, investors should only be rewarded for non-diversifiable risk.

Answer 1

d. Because investors can easily eliminate risk through diversification, investors should only be rewarded for non-diversifiable risk.

Reason:

Risk and Return

• In investing, risk and return are highly correlated. Increased potential returns on investment usually go hand-in-hand with increased risk. Different types of risks include project-specific risk, industry-specific risk, competitive risk, international risk, and market risk. Return refers to either gains and losses made from trading a security.
• The return on an investment is expressed as a percentage and considered a random variable that takes any value within a given range. Several factors influence the type of returns that investors can expect from trading in the markets.
• Diversification allows investors to reduce the overall risk associated with their portfolio but may limit potential returns. Making investments in only one market sector may, if that sector significantly outperforms the overall market, generate superior returns, but should the sector decline then you may experience lower returns than could have been achieved with a broadly diversified portfolio.
• A person making an investment expects to get some returns from the investment in the future. However, as future is uncertain, the future expected returns too are uncertain. It is the uncertainty associated with the returns from an investment that introduces a risk into a project. The expected return is the uncertain future return that a firm expects to get from its project. The realized return, on the contrary, is the certain return that a firm has actually earned.
• The realized return from the project may not correspond to the expected return. This possibility of variation of the actual return from the expected return is termed as risk. Risk is the variability in the expected return from a project. In other words, it is the degree of deviation from expected return. Risk is associated with the possibility that realized returns will be less than the returns that were expected. So, when realizations correspond to expectations exactly, there would be no risk.