Final answer:
Control risk is the chance that a company's internal control system will fail to prevent or spot significant misstatements in financial reports. It is a critical concept in auditing and financial analysis, particularly when considering the expected and actual rates of return of an investment, balanced against its risk profile.
Step-by-step explanation:
Control risk is defined as the risk that a material error in the balance or transaction class will not be prevented or detected by the entity's internal control system. It is a component of audit risk, which also includes inherent risk and detection risk. Understanding this is crucial for both auditors and the company to ensure that the financial statements are free from material misstatements.
The expected rate of return is the average return anticipated on an investment, typically expressed as a percentage. Evaluating this involves considering the level of risk associated with the investment. For instance, default risk is concerned with the borrower's inability to repay a loan or bond, while interest rate risk pertains to the potential loss from a change in interest rates after acquiring a bond.
A low-risk investment will likely yield actual returns that are close to the expected rate of return consistently, whereas a high-risk investment may have actual returns that fluctuate significantly from the expected rate, being much higher or lower in different periods. Ultimately, the actual rate of return is the total return an investment has generated over a specified period, including both interest and capital gains.