📘 RISK & RETURN ON INVESTMENT — Reviewer • Shows if investment was:
○ Profitable
○ Worth the risk
🎯 Learning Outcomes
○ Better than other opportunities
• Define risk and return in investments • Guides future investment decisions
• Explain their relationship
• Evaluate how investors make decisions based on risk and
🧩 Types of Investment Risks
return
• Market Risk → risk of losing money due to changes in
market conditions
🏦 Introduction
• Credit Risk → borrower fails to repay
• Investors make decisions every day. • Liquidity Risk → cannot easily convert an asset into cash
• Some investments are safe, others are risky. without losing value
• Why take risks? • Inflation Risk → rising prices reduce purchasing power
→ Because higher risk often leads to higher potential ○ If inflation > investment return → lose real value
return. • Business Risk → company performs poorly due to internal
• This lesson explains how this works. problems
• Interest Rate Risk → changes in interest rates affect
returns
📍 Key Concepts • Political Risk → from government policy changes, laws, or
⚠️What is Investment Risk? instability
• The chance that the actual return from an investment will
be different from what was expected. 🛡️Types of Other Risk
• Risk means uncertainty — you might earn more, earn 📌 Systematic Risk
less, or even lose money.
• Affects entire market
• Cannot be avoided
💰 What is Return? Examples: inflation, recession, political instability, exchange
• The profit or gain earned from an investment over a rate movements
period of time. • Can only be managed
Examples of returns:
○ Interest from savings 📌 Unsystematic Risk
○ Dividends from stocks
○ Profit from selling an asset • Affects specific company or industry
○ Capital gains • Can be reduced through diversification
• Measures how much you earned relative to how much Examples: mismanagement, product recall, industry
you invested. downturn
🔁 Risk–Return Trade-Off 💹 Returns: Types
• Higher risk → higher potential return ⭐ Expected Return
• Lower risk → lower potential return
• Estimated profit based on probabilities
• Investors choose based on comfort with risk
• Formula:
→ Expected Return = Σ (Probability × Expected Outcome)
❓ Why is Risk Important? • Helps compare investments
• Affects:
○ Investment choices 🔻 Required Return
○ Expected profits
• Minimum return expected for a certain risk level
○ Financial planning
• Higher-risk → higher required return
○ Investor behavior
• Helps avoid unexpected losses
📌 Actual Return
📈 Why is Return Important?
• Real profit earned after investment period
• Compare: expected vs required vs actual → evaluate
performance
🧮 Risk Measurement Tools
• Standard Deviation → measures how much actual returns
differ from the average return; volatility
○ Higher = more risk
• Variance → shows spread of returns from average
• Beta Coefficient → sensitivity vs market
○ Beta > 1 → more volatile
○ Beta < 1 → less volatile
○ Beta = 1 → moves with market
• Value-at-Risk (VaR) → estimates worst-case losses
📊 Portfolio Concepts
📌 Diversification
• Spreading investments across assets to reduce risk
• Don’t put all your money in one basket
📌 Portfolio Return
• Total return from all investments combined
📌 Portfolio Risk
• Total risk of all investments combined
• Diversification reduces unsystematic risk & stabilizes
returns
🧠 Decision Making
• Investors compare:
○ Risk level
○ Expected return
○ Risk tolerance
• Helps choose best investment for goals
🏁 Summary
• Risk = uncertainty
• Return = reward
• Higher risk → higher potential return
• Diversification reduces risk
• Understanding risk leads to smarter investment decisions