Investment decisions are always about two things: return (what you gain) and risk (uncertainty about what you gain). The central idea is the risk–return trade-off: higher expected returns generally require accepting higher risk. Investors manage risk by using diversification, i.e., holding a mix of assets rather than putting all money in one investment.
This chapter is exam-friendly because it is mostly definitions + neat tables.
You should be able to:
Return is the benefit/gain from an investment over a period. It may come from:
Example: buying a share gives return from dividend + price increase.
Risk is the uncertainty that actual return will differ from expected return. In simple exam words: risk is the possibility of loss or variability in returns.
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Systematic vs unsystematic risk:
Thus, diversification mainly reduces unsystematic risk.
Risk–return trade-off: higher expected return generally comes with higher risk.
Conclusion: investors demand risk premium for taking additional risk.
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Investment decisions are always about two things: return (what you gain) and risk (uncertainty about what you gain). The central idea is the risk–return trade-off: higher expected returns generally require accepting higher risk. Investors manage risk by using diversification, i.e., holding a mix of assets rather than putting all money in one investment.
This chapter is exam-friendly because it is mostly definitions + neat tables.
You should be able to:
Return is the benefit/gain from an investment over a period. It may come from:
Example: buying a share gives return from dividend + price increase.
Risk is the uncertainty that actual return will differ from expected return. In simple exam words: risk is the possibility of loss or variability in returns.
General rule (concept):
Investors demand a risk premium (extra return) for taking additional risk.
Common classifications:
Other risk terms you may mention (concept):
Diversification means investing in different assets/securities so that poor performance of one is offset by better performance of another.
Key logic:
Different assets → different return patterns → losses in one may be balanced by gains in another → overall portfolio return becomes more stable (concept)
A portfolio is a collection of investments (shares, bonds, deposits etc.). Investors build portfolios to:
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Systematic risk is market-wide risk that affects most securities due to economy-level factors.
Systematic risk cannot be fully eliminated by diversification because it impacts the entire market, not just one company (concept).