CHAPTER 8 RISK AND RATE OF RETURN

Generally, higher return, higher risk;

In order to make investors invest in risky investments this usually entails higher returns

Common forms of investments: Risk Return

Bonds low Low
Stocks high high

Risk – Chance that some unfavorable events will occur

Risks are always expected when doing investments; analysis (stand-alone basis & portfolio basis) is more on
which is riskier/which risk are you more willing to bet on?

No investment should be undertaken unless rate of return is high enough to compensate for the
perceived risk

STAND ALONE RISK VS. PORTFOLIO RISK

STAND ALONE RISK PORTFOLIO RISK

users Small business Financial institutions (required by
law), investors with larger
investment capabilities

definition The risk an investor would face if

he/she held only in one asset.

Putting your eggs in only one

statistical measurement
basket. Thus, when loss is
acquired it is 100% loss. If profit
1000%
Probability distribution
Expected rate of return
Historical, or past realized, rates
of return
Standard deviation
Coefficient of variation
Risk free – when expected return can be measured precisely

Expected rate of return ≠actual rate of return ( thus, usually comes in ranges)