Risk and return management
Risk and Return Management
Risk and return management
Darlene LaBarre
MBA6161 Fin Markets & Institutions
Capella on Line
The risk-return spectrum is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment.[citation needed] The more return sought, the more risk that must be undertaken!
The progression
There are various classes of possible investments, each with their own positions on the overall risk-return spectrum. The general progression is: short-term debt; long-term debt; property; high-yield debt; equity. There is considerable overlap of the ranges for each investment class.
All this can be visualized by plotting expected return on the vertical axis against risk (represented by standard deviation upon that expected return) on the horizontal axis. This line starts at the risk-free rate and rises as risk rises. The line will tend to be straight, and will be straight at equilibrium - see discussion below on domination.
For any particular investment type, the line drawn from the risk-free rate on the vertical axis to the risk-return point for that investment has a slope called the Sharpe ratio
Option and futures contracts often provide leverage on underlying stocks, bonds or commodities; this increases the returns but also the risks. Note that in some cases, derivatives can be used to hedge, decreasing the overall risk of the portfolio due to negative correlation with other investments.
The progression?
The existence of risk causes the need to incur a number of expenses. For example, the more risky the investment the more time and effort is usually required to obtain information about it and monitor its progress. For another, the importance of a loss of X amount of value is greater than the importance of a gain of X amount of value, so a riskier investment will attract a higher risk premium even if the forecast return is the same as upon a less risky investment. Risk is therefore something that
Risk and return management
Darlene LaBarre
MBA6161 Fin Markets & Institutions
Capella on Line
The risk-return spectrum is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment.[citation needed] The more return sought, the more risk that must be undertaken!
The progression
There are various classes of possible investments, each with their own positions on the overall risk-return spectrum. The general progression is: short-term debt; long-term debt; property; high-yield debt; equity. There is considerable overlap of the ranges for each investment class.
All this can be visualized by plotting expected return on the vertical axis against risk (represented by standard deviation upon that expected return) on the horizontal axis. This line starts at the risk-free rate and rises as risk rises. The line will tend to be straight, and will be straight at equilibrium - see discussion below on domination.
For any particular investment type, the line drawn from the risk-free rate on the vertical axis to the risk-return point for that investment has a slope called the Sharpe ratio
Option and futures contracts often provide leverage on underlying stocks, bonds or commodities; this increases the returns but also the risks. Note that in some cases, derivatives can be used to hedge, decreasing the overall risk of the portfolio due to negative correlation with other investments.
The progression?
The existence of risk causes the need to incur a number of expenses. For example, the more risky the investment the more time and effort is usually required to obtain information about it and monitor its progress. For another, the importance of a loss of X amount of value is greater than the importance of a gain of X amount of value, so a riskier investment will attract a higher risk premium even if the forecast return is the same as upon a less risky investment. Risk is therefore something that
References: Saunders, A., & Cornett, M. M. (2014). Financial institutions management: A risk management approach (8th ed.). New York, NY: McGraw-Hill/Irwin.