Financial Risk Manager Part 1

Explanation

The correct answer is C because it accurately describes the fundamental risk-reward tradeoff principle in finance.

Key Concepts:

• Risk-Reward Tradeoff: This is a core principle stating that higher potential returns are generally associated with higher levels of risk.
• Direct Relationship: As investment risk increases, the potential for reward also increases - this is a direct, not inverse, relationship.
• Compensation for Risk: Investors demand higher potential returns to compensate for taking on additional risk.

Why Other Options Are Incorrect:

A is incorrect because risk and potential reward are directly related, not inversely. Higher risk investments offer the potential for higher returns to compensate investors for taking on that additional uncertainty.

B is incorrect because it contradicts the basic principle. Lower-risk investments (like government bonds) typically offer lower potential returns than higher-risk investments (like startup companies).

D is incorrect because while specific risk levels vary by financial product, the general principle that higher risk correlates with higher potential reward applies across virtually all investment types.

Important Nuances:

• Higher risk doesn't guarantee higher returns - it only provides the potential for higher returns
• The actual outcome may still result in losses despite higher risk
• Risk represents the uncertainty that actual returns will deviate from expected returns
• Greater risk means a wider range of possible outcomes, including both larger gains and larger losses

This principle is foundational to modern portfolio theory and investment decision-making.