05 Risk and Return Flashcards
Investors want to be (…) for taking higher amounts of risk.
Compensated, rewarded
The standard deviation of a distribution..
HAS to be a positive value
Two investments have the same level of risk, but different rates of return. Investors, in this case will choose..
The investment with a higher rate of return.
Function to calculate the expected return of an investment
=AVERAGE(
When comparing the returns of an individual share to a market index..
The returns of the individual share will show more variability than those of the market index.
The normal distribution is commonly called..
The bell curve
The normal distribution is..
Symmetric
If the capital gain return from owning a share is positive..
Then the total return from owning the same share does not have to be negative.
Function to calculate Standard Deviation
=STDEV(
The rate of return that investors require depends on..
Both the price of the investment AND the risk associated with the investment
The risk-return trade off
The relationship between risk and return
The capital gain component of a share’s return considers..
The increase in the price of a share divided by the beginning price of the share.
Bonds are…
NOT riskier than shares, on average. (bonds are fixed interest investments)
Standard deviation
Allows us to measure risk of investment.
Relationship between risk and return
In finance, investors need to be compensated (rewarded) for holding additional risk, therefore higher risks mean higher expected returns.
Invest in savings account versus the share market
You would expect a lower expected return on average for putting your money into a savings account relative to holding stocks. This is because in finance, investors demand a higher return for taking higher risks, and stocks are more risky than fixed-interest savings accounts.
Investing in start-up tech company versus the biggest company on share market
You would expect a higher expected return on average for putting your money into a start-up relative to a big company. This is because in finance, investors demand a higher return for taking higher risks, and small companies are more risky than large, well-established companies.
What does ‘risk’ mean in finance?
Risk means uncertainty and can go both ways – up and down.
Investors will always choose…
Lower risk for a given level of return and higher return for a given level of risk.
Total Return (equation)
Total Return = (Current Price - Price Paid) / (Price Paid)
With the same level of risk..
Investors prefer the investment with the higher return.
If investors expect the same return..
Investors prefer the investment with less risk.
If standard deviation is small (curve is steeper, closer)..
Risk is small.
