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The risk–return spectrum (also called the risk–return tradeoff or risk–reward) is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment. The more return sought, the more risk that must be undertaken.
The relationship between risk and return is often represented by a trade-off. In general, the more risk you take on, the greater your possible return. Think of lottery tickets, for example.
The risk-return ratio is then defined and measured, for a specific time period, as: = / Note that dividing a percentage numerator by a percentage denominator renders a single number. This RRR number is a measure of the return in terms of risk.
Investors are risk-averse in nature and possess the same expectations; Efficient markets with limited opportunity for arbitrage; Perfect capital markets; Infinite number of assets; Risk factors are indicative of systematic risks that cannot be diversified away and thus impact all financial assets, to some degree. Thus, these factors must be:
Related is the concept of "risk return", which is the rate of return minus the risks as measured against the safest (least-risky) investment available. Thus if a loan is made at 15% with an inflation rate of 5% and 10% in risks associated with default or problems repaying, then the "risk adjusted" rate of return on the investment is 0% .
E(R i) is an expected return on security E(R M) is an expected return on market portfolio M β is a nondiversifiable or systematic risk R M is a market rate of return R f is a risk-free rate. When used in portfolio management, the SML represents the investment's opportunity cost (investing in a combination of the market portfolio and the risk ...
Pure Risk is a type of risk where the outcome cannot be controlled, and only has two outcomes which are complete loss or no loss at all. [4] An example of pure risk for an individual would be owning an equipment, there is risk of it being stolen and there would be a loss to the individual, however, if it weren't stolen, there is no gain but ...
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