The Relationship Between Risk And Expected Returns

The idea of “risk” is used in many fields and industries. There has been large efforts made towards the understanding of risk. Since, risk varies so much depending on the field of study, the need for learning about it is warranted. As can be imagined, the importance of risk in a market economy is crucial. In the 1990s, JP Morgan made the Value at Risk (VaR) a central component of its work efforts (Cecilia-Nicoleta, Anne-Marie, & Carmen-Maria, 2011).

The lower the risk that is associated with an investment, that investment usually has a potential for lower returns. Conversely, if there are high levels of risk associated with an investment, and in turn a potential for a higher return.

Harry Markowitz 1991, developed a theory of “Portfolio choice”, that allows the investors to examine the risk as per the expected returns. In modern World, this theory is known as Modern portfolio theory (MPT). It attempts to attain the best portfolio expected return for a predefined portfolio risk, or to minimise the risk for the predefined expected returns, by a careful choice of assets. Though it’s a widely used theory, still has been challenged widely. The critics question the feasibility of theory as a strategy for

An investment philosophy is one’s approach to tolerance for risk in investments. It may be conservative which means you accept very little risk and are generally rewarded with relatively low rates of return. Another investment philosophy is moderate also known as risk indifference, this means one accepts some risk as they seek capital gains through slow and steady growth. Lastly, one may have an aggressive investment philosophy or be more of a risker seeker. Often times, people strive for a very high return by accepting a high level of risk. Going into the game, we were informed that like

magnitude of these risks, this paper advocates for a more proactive solution. Active investing in

Cernauskas, D., & Tarantino, A. (2011). Essentials of Risk Management in Finance. Hoboken: John Wiley & Sons, Inc.

With attention to the previous information given, the principle of risk-return tradeoff is based on the thought that individuals are opposed to taking risk, meaning individuals would prefer to get a certain return on their investment rather than risking and getting an uncertain return. (Titman, Keown, & Martin, 2014) This principle tells us that investors will receive higher returns for taking on a bigger risk however; a challenge often seen in investors is how to calculate the tradeoff between risks and return with riskier investments. A higher expected rate of return is not always a higher actual return.

This essay will highlight the use of Capital asset pricing model ( CAPM ) to be considered as a pricing theory model for assets . CAPM model helps investors to analyse the risk and what expectation to keep from an investment (Banz , 1981) . There are two types of risk

As indicated by the case study S&P 500 index was use as a measure of the total return for the stock market. Our standard deviation of the total return was used as a one measure of the risk of an individual stock. Also betas for individual stocks are determined by simple linear regression. The variables were: total return for the stock as the dependent variable and independent variable is the total return for the stock. Since the descriptive statistics were a lot, only the necessary data was selected (below table.)

Of the many risk profiles that exist, namely: cash profile, conservative profile, moderately conservative profile, growth profile, and high growth profile, I would settle on balanced profile in allocating assets because an investor would want to steadily grow his investment over time (Bailey & Kinerson, 2005). I will be comfortable taking on a greater level of risk to achieve this. With the balanced profile I will be capable of placing more of my investments into growth assets. This will increase the possibility of rises and falls to my investment value. The possibility of a negative return would be very remote with the balanced profile. This type of asset allocation creates a balance between seeking capital for growth and wealth preservation (Bailey & Kinerson, 2005). With the balanced risk profile, an investor accepts the risk in the pursuit of long term gain. With the balanced risk profile an investor seeks reasonable level of returns and accepts a medium level of risk. This kind of asset allocation makes an investor to accept the possibility of losses from time to time while he expects growth in assets over the medium to longer term (Bailey & Kinerson, 2005). With a balanced risk profile an investor will have a balanced allocation between stable "income" investment assets such as cash and fixed interest and their allocation to more volatile growth investments such as shares and property (Bailey & Kinerson, 2005). Balanced risk profile is suitable

The analysis of this paper will derive the validity of the Fama and French (FF) model and the efficiency of the Capital Asset Pricing Model (CAPM). The comparison of the Fama and French Model and CAPM (Sharpe, 1964 & Lintner, 1965) uses real time data of stock market to practise its efficacy. The implication of the function in realistic conditions would justify the utility of the CAPM theory. The theory suggests that the expected return demanded by investors on a risky asset depends on the risk-free rate of interest, the expected return on the market portfolio, the variance of the return on the market portfolio, and

Whether it is investing, driving or just walking down the street, everyone exposes themselves to risk. Your personality and lifestyle play a big role in how much risk you are comfortably able to take on. If you invest in stocks and have trouble sleeping at night, you are probably taking on too much risk. (For more insight, see A Guide to Portfolio Construction.) Risk is defined as the chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment.

At one point or another odds are that individuals have thoughts about that one investment that will make them rich quick. Then the reality of it all sinks in and thoughts of getting rich quick are instead replaced with concerns about the potential possibility that the investment could yield one losing everything or even just the uncertainty of it all. There is a name for this in the finance investment world and it is called; risk. Authors Besley & Brigham of the text book CFIN 4, 4th Edition explain, “Although most people view risk as a chance of loss, in reality risk occurs any time we cannot be certain about the future outcome of a particular activity or event. Consequently, risk results from the fact that an action such as investing can produce more than one outcome in the future.” (Besley & Brigham, 2016, pg. 126). When it comes to investing and the level of risk associated, an individual should know as much as possible about that investment and if one is unable to obtain such information, it should be carefully considered to determine if the investment is worth the risk, as illustrated in the below scenario.

In their research study, Souder & Myles (2010) identify that risk is chiefly fundamental to investing. Böhringer & Löschel (2008) further add that there is no discussion of returns or performance that is deemed meaningful in the absence of at least some mention of the involved risk. However, the trouble for investors, who have just entered into the marketplace, involves the process of figuring where risk really lies, as well as what the difference between the various levels of risks. Relating to the manner, in which risk is fundamental to investments, a significant number of new

Investment is one of the most essential ways to manage and appreciate capital. It is well known that investment has risk, and higher return with higher risk. The risk is coming from a bunch of factors. Systematic risk and unsystematic risk are two terms which distinguish the effective range of the investment market. Systematic risk describes widely effect which individual cannot manage, control and avoid. What people can do is to reduce lost to the minimum. Unsystematic risk is also called as “ special risk” which it is more individual and investor can control even avoid it. Thus, this paper will focus on the what kinds of factor will bring systematic risk and how these factors affect the investment market. Three fundamental aspects will