What does it means ''The higher the risk of an investment, the higher the expected rate of return must be''

Question

can you give me an examples

Answer 1

Well, if you were going to invest in something - especially if you were going to invest a high amount in something, you would want to be sure it has a good probability of giving you a high return right?   You wouldn't want to put alot of your money towards something that had little to no chance of giving you at least as much back - with the intent of giving you more back.   For example, I'll make up some stocks - lets say there is an ice cream stock for different flavors - I would feel comfortable investing highly in vanilla or chocolate, with the probability most people would buy those so therefor I would get a big return back - more money back than I put in.  But I wouldn't invest in fish flavored ice cream because that has a little chance to give me more money back than I put in. - The expected rate of return isn't there, so why put in a high investment right.

Thats a bad example but hopefully it makes sense. Basically if you're going to put your precious money towards something and you're risking it, putting alot in, then the company/stock/etc whatever it may be you're investing in should have a high chance to give you even more back than what you put in - you don't want to risk alot on something that could lose you money.

Answer 2

The risk-return tradeoff is one of the 10 main axioms of finance.

Examples:

Bank accounts / Treasury bills from the government - Very little risk, your only risk of your money going down in value is if the country gets taken over or the banks go bankrupt somehow which is quite unlikely. So you get very poor return, maybe 1-4%.

Bonds - Slightly more risky but not really since you buy them and you get a constant return over the life of the bond and then your money back, you might get 5%

Stock market - Riskier since any news, lawsuits, whatever can affect the stock price. You can make 12% in the stock market per year fairly easily on average, but you will also lose some money. If what you make is higher than what you lose, you win.

Stock options/forex - Triple-digit earnings are possible through the use of leverage (100%+), although quite risky. You may lose everything you invest IF you don't know what you are doing. I would also put real estate in this catagory.

Answer 3

It means that, the more the risk you are willing to take in a specific investment, the more the return you want to receive.

Because higher risk, imposes higher possibility of loss.

An example, mortgage industry currently, if you are going to invest one dollar today in mortgage industry, you will have a high possibility to lose your money, so in order take such risk, you must have something to encourage you to invest, which is the return. So you expect high return to encourage you to make such risky investment.

Answer 4

The riskier the investment, the chance is higher for a greater reward.

Example:  You're on one side of a street. On the other side is One million dollars. But there a hundreds of cars passing every minute. It's going to be risky to try and get to that money without getting hit. But the reward is high if you do.

Same scenario but there's only one hundred dollars on the other side. Now there's only 10 cars that pass every minute. Not so much risk but the reward is lower.

Answer 5

The greater the chance I could lose some or all of my money the more you have to pay me to take that chance.

Answer 6

Let's say you are considering making two loans. One to a young couple with stable jobs just starting out looking to buy a home. The other to a local bum needed to buy a bottle of gin. One of these loans would be more risky than the other. Would you charge them the same interest rates? Or would you charge more for the one with the greatest risk?