Question

Investments have risk associated with them. The riskier the investment, the higher the rate of return it usually takes to attract investors. Do you remember what this concept is called?

1) Risk premium
2) Risk tolerance
3) Risk aversion
4) Risk-return tradeoff

Answer 1

The concept that describes the relationship between investment risk and potential returns is the risk-return tradeoff, with higher risk necessitating a higher potential return, commonly expressed as a risk premium.

Step-by-step explanation:

The concept that describes the relationship between the potential return of an investment and the risk associated with it is known as the risk-return tradeoff. Investors demand a higher return for taking on more risk, which is where the term risk premium originates. However, the tradeoff ultimately depends on an investor's risk tolerance, or the degree of variability in investment returns that an investor is willing to withstand. High-risk investments are expected to yield higher returns to compensate for the greater chance of loss. Conversely, low-risk investments typically offer smaller returns due to their more stable expected outcomes.

An investment's expected rate of return is the anticipated amount of money that an investment will generate over a period. It estimates future interest payments, capital gains, or profitability increases and is often expressed as an annual percentage rate. The actual rate of return is the gain or loss on an investment over a specified period, including interest and dividends received, as well as capital gains realized on the sale of the asset.