Risk and Return on Investments

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Risk and Return on Investments

Introduction

In the world of investment, risk is termed as opportunity an investment’s in the actual return can be diverse than expectation. Technically, risk statistics measurement is performed through standard deviation. Low risk is linked with the low returns while high risk is connected by high returns. The return/ risk tradeoff termed as balance between lowest risk and highest return.

The relationship between return and risk applied by investors enables them to gain high return by application of low risk. For better management of investment, the investor succeeds in quantification of its direction and relationship (Hampton, 2011). This relationship requires the study impacts of every element. The measurement effect of decrease or increase risk on investment return is determined. The main relationship type of return and risk include, direct relationship between return and risk where the high risk in relation to high return is explained as the high risk taken by investor for a reward (Hampton, 2011). When investor invests one million, the loss risk is estimated as million dollars. If he earns a return of 10%, the return is less through investing of millions where risk loss is millions. The low risk in relationship to low return is seen as the direct relationship in return and risk. If investor reduces investment, he reduces the risk loss now his return reduces.

The second type is negative relationship between return and risk. In this category, high risk amounts to low return. When investor’s investment increases amount of acquiring high return through return increase, he encounters low return due to the nature of project. When increasing investment, no benefit in the project is requiring (Hampton, 2011). In addition, low risk leads to high return where in the projects the low investment amount can result to high return. For instance, Indian government requires money. Due to government requirement of the amount in government and emergency, there is provision of high return in small investment project. This opportunity for money investment will lead to high return for small risk on money loss.

Risk and Return Example

Foreign –exchange investment risk and return: when making an investment in foreign country individual should consider a fact that currency rates of exchange may change the value of asset. Foreign exchange risk employs to almost all financial instruments, which are in currency apart from your local currency (Hampton, 2011). For instance, if a person lives in America and makes investment in Canadian stock using Canadian dollars, whether share value increases, an individual can lose money when Canadian dollar depreciates in association to American dollar. The person can gain money if share value appreciates and Canadian dollar appreciates about American dollar.

Which are more risky bonds or common stocks?

The fact to consider while one is making an investment is that incurs higher returns have higher risks. Safer investments usually have low risk but returns are lower. Different risk levels applying to bonds and common stocks, corporate bonds normally have lowest risk of investment types and offers lower returns (Hampton, 2011). Common stocks present highest risk for investments but have highest potential in returns. Bonds issued through companies represent broadest part of bonds markets compared to US Treasury bonds or securities offered via federal agencies. The risk related with corporate bonds generally depends on financial performance and stability for company issuing bonds, since if company becomes bankrupt it cannot be in position to pay back value of bond or return on an investment. One can assess risk through checking company’s rate of credit via ratings agencies like Moody and Standard & Poor’s.

In considering risk levels, corporate bonds holds lowest risk compared to common stocks kind of investment (Hampton, 2011). This is possible provided an individual chooses right company for which put his investment. The major reason for this was that in occurrence of bankruptcy, those who hold corporate bonds maintain stronger claim on payment than an individual or group holding common stocks. Bonds generally carry lower risk of return for an investment because performance of common stocks is better. Common stocks are associated with highest risk since holders are presented last in payment on occurrence of bankruptcy.

Understanding risk and return

Understanding relationship between return and risk how they are influence by time is the most significant aspects for investing your capital in future. In knowing how they operate and individual’s perception on risk may assist in making investment decisions, which meets your financial requirements and goals best. An investment risk can be termed as the possibility an individual may lose money on an investment or that investments cannot maintain rate with inflation (Hampton, 2011). All investments usually carry risk but a risk level varies depending on kind of investment. Investments perceived to contain higher level in terms of risks have potential to earn an individual higher return on investment for example, growth assets. Investment that earn lower returns if invested like defensive assets, normally carry lower levels of risk. Risk may arise from different angles depending on kinds of investments a person wants to invest. For instance, changes in economies, investments markets, political and social environments may affect different investments in various ways and influence them to either increase or decrease in value.

The common kinds of risk related to investing comprise of financial losses, changes in inflation, currency prices or interest rates and liquidity. Investment return is amount earned or lost on an investment. Return and risk are linked, greater investment opportunity have potential to attain higher returns, but are largely associated with higher risk. Whereas few individuals prefer taking risk, it is normal part in investing. In fact, risk taking is beneficial and of value when undertaking an investment opportunity. As an investor, a person has to accept certain risks in order to attain higher returns. However, it is of significant to ensure that you are not venturing in unnecessary risk. For example, before an individual invest his retirement savings then he requires understanding their risk profile.

The person needs to opt on how comfortable he is with risk and amount taken to attain the returns he wants. For instance could he be comfortable whether value of investment goes up or down over short period. May be he prefers consistent returns to a long term. In understanding how various asset classes run can assist you opt that investment options match their financial goals and risk profile.

References

Hampton, J. J. (2011). The AMA handbook of financial risk management. New York: American Management Association.