Risk And Return Trade Off In Financial Management

In other words it is the degree of deviation from expected return. Using this principle individuals associate low levels of uncertainty with low potential returns and high.

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Such balance is called risk-return trade off and every financial decision involves this trade off.

Risk and return trade off in financial management. Risk is the variability in the expected return from a project. Risk is associated with the possibility that realized returns will be less than the returns that were expected. The concept of financial risk and return is an important aspect of a financial managers core responsibilities within a business.

The management should try to maximize the average profit while minimizing the risk. Key current questions involve how risk should be measured and how the. Whilst the word return is most commonly associated with a gain it is perfectly possible to have a negative return obviously indicating an actual loss on your investment.

It also adds to the growing supply of data suggesting we should re-examine the traditional financial view that investment is about trading off risk and return with greater risk ultimately. That is the firm sold equity shares and raised N5000. Definition of Risk Return Trade Off.

The risk return trade-off involved in managing the firms liquidity via investing in marketable securities is illustrated in the following example. The prime objective of Financial Management is maximize the value of the firm which is possible only when well balanced financial decisions are taken. The risk-return trade-off is the concept that the level of return to be earned from an investment should increase as the level of risk increases.

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About Press Copyright Contact us Creators Advertise Developers Terms Privacy Policy Safety How YouTube works Test new features Press Copyright Contact us Creators. In this lesson we will talk briefly about the riskreturn tradeoff. Generally the more financial risk a business is exposed to the greater its chances for a more significant financial return.

AN INTRODUCTION TO RISK AND RETURN CONCEPTS AND EVIDENCE by Franco Modigliani and Gerald A. This possibility of variation of the actual return from the expected return is termed as risk. Pogue1 Today most students of financial management would agree that the treatment of risk is the main element in financial decision making.

Though this is one of the first things investors think of another aspect though comparatively less discussed but equally as important is the quantum of risk being. The projects promising a high average profit are generally accompanied by high risk. The finance manager in trying to achieve the optimal capital structure has to determine the minimum overall total risk and maximize the possible return to achieve the objective of higher market value.

Thus a firm has reach a balance trade-off between the financial risk and risk of non-employment of debt capital to increase its market value. This trade off which an investor faces between risk and return while considering investment decisions is called the risk return trade off. Whilst risk refers to the probability or likelihood of losses return measures the actual gain or loss your investment generates.

That is given two investments at the exact same level of risk all other things being equal every rational investor will invest in the one that offers the higher return. Risk-Return Tradeoff is the relationship between the risk of investing in a financial market instrument vis-à-vis the expected or potential return from the same. Risk-Return Trade-Off The concept that every rational investor at a given level of risk will accept only the largest expected return.

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Higher risk is associated with greater probability of higher return and lower risk with a greater probability of smaller return. The financial manager in order to maximize shareholders wealth should strive to maximize returns in relation to the given risk. The risk-return tradeoff states that the potential return rises with an increase in risk.

A proper balance between return and risk should be maintained to maximize the market value of a firms share. The trade-off between risk and return is a key element of effective financial decision making. Firm A and B are identical in every aspect but one firm B has invested N5000 in marketable securities which have been financed with equity.

This includes both decisions by individuals and financial institutions to invest in financial assets such as common stocks bonds and other securities and decisions by a firms managers to invest in physical assets such as new plants and equipment. Conversely this means that investors will be less likely to pay a high price for investments that have a low risk level such as high-grade corporate or government bonds. While making investment decisions one important aspect to consider is what one is getting in return for the investment being made.

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