Final answer:
Less risky securities have lower expected returns as investors need to be compensated for higher risk with higher potential returns. The expected rate of return is balanced against the risk of the investment, with high-risk options needing to offer higher returns to attract investors.
Step-by-step explanation:
The student's question asks about the relationship between the risk of an investment and its expected return. Less risky securities typically have lower expected returns because the potential for high returns generally comes with a higher level of risk. This is because investors need to be compensated for taking on additional risk through the potential of receiving a higher return. Therefore, the correct answer is c. lower expected.
For example, bank accounts offer very low risk but also provide very low returns. Conversely, stocks, which are riskier, offer the possibility for higher returns. This tradeoff between risk and return is fundamental in financial markets. Riskier investments must provide a higher expected return to attract investors who might otherwise avoid them due to the potential for greater losses.
To analyze investments, three factors must be considered: the expected rate of return, the risk of returns deviating from the expectation, and the investment's liquidity. For instance, a high-risk investment has a wide range of possible outcomes and, thus, the actual returns may vary significantly from the expected returns. On the other hand, a low-risk investment tends to have actual returns that are more consistently aligned with the expected rate of return.