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Understanding Risk and Return in Finance

The document discusses the concepts of risk and return in finance, explaining that risk is the possibility of unfavorable investment outcomes while return is the gain or loss generated by an investment. It emphasizes the risk-return trade-off, where higher potential returns are associated with higher risks. Additionally, it outlines methods for calculating returns and measuring risk using standard deviation.

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3 views10 pages

Understanding Risk and Return in Finance

The document discusses the concepts of risk and return in finance, explaining that risk is the possibility of unfavorable investment outcomes while return is the gain or loss generated by an investment. It emphasizes the risk-return trade-off, where higher potential returns are associated with higher risks. Additionally, it outlines methods for calculating returns and measuring risk using standard deviation.

Uploaded by

raven.pantaleon.24
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Risk and Return

1st Term | AY 2025-2026

Prepared by Christian Alec A. Borja


Risk and Return
What Is Risk?
In finance, risk refers to the possibility that the actual

results of an investment or decision may turn out

differently, often less favorably, than what was

originally anticipated. Risk includes the possibility of

losing some or all of an original investment.


What Is a Return?
A return is the gain or loss that an investment

generates over time. It can be expressed nominally as

the change in dollar value of an investment. A return

can also be expressed as a percentage derived from

the ratio of profit to investment.


What Is Risk & Return?
An invested money can render higher profits only if

the investor will accept a higher possibility of losses.

Using this principle, individuals associate low levels of

uncertainty with low potential returns using this

principle and high levels of uncertainty or risk with

high potential returns.


Risk and Return
The return is calculated as Ending Value – Initial

Investment / Initial Investment * 100% = Return

Example: You invest ₱10,000 in a stock. After one

year, your investment grows to ₱11,500.


Return Calculation
The return can be in different forms: capital

appreciation (price increase) and dividends (profit

distribution).

Formula for Expected Return for multiple investment

outcomes: E (R) = √ ∑ (Pi * Ri)

Where: Pi is Probability of Outcome Ri is Expected

Return in that Outcome.


Measuring Risk
Risk is commonly measured using standard deviation

(σ), which shows how much actual returns deviate

from expected returns.

σ = √ ∑ Pi (Ri – E(R)) ²
Risk-Return Trade-Off
The risk-return trade-off implies that the potential for

higher returns generally comes with a higher level of

risk. Low-risk investments, such as government

bonds, typically offer lower but more stable returns,

while high-risk options like stocks and

cryptocurrencies may provide greater returns but

also carry a higher likelihood of substantial losses.

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