Question

Risk and Rates of Return: Introduction

Risk is an important concept affecting security prices and rates of return. Risk is the chance that some unfavorable event will occur, and there is a trade-off between risk and return. The higher an investment’s risk, the (Select One: lower, higher, equivalent) _________ the return required to induce investors to purchase the asset. This relationship between risk and return indicates that investors are risk (Select One: ambivalent, averse) ____________ ; investors dislike risk and require (Select One: Lower, Higher, Equivalent) _________ rates of return as an inducement to buy riskier securities. A (Select One: Risk Premium, Par Value, Correlation Coefficient) ___________ represents the additional compensation investors require for bearing risk; it is the difference between the expected rate of return on a given risky asset and that on a less risky asset. An asset’s risk can be considered in two ways: On a stand-alone basis and in a portfolio context.

Answer 1

Risk is an important concept affecting security prices and rates of return. Risk is the chance that some unfavorable event will occur, and there is a trade-off between risk and return. The higher an investment’s risk, the higher the return required to induce investors to purchase the asset. This relationship between risk and return indicates that investors are risk averse; investors dislike risk and require higher rates of return as an inducement to buy riskier securities. A risk premium represents the additional compensation investors require for bearing risk; it is the difference between the expected rate of return on a given risky asset and that on a less risky asset. An asset’s risk can be considered in two ways: On a stand-alone basis and in a portfolio context.