Explanation:
The principle of risk-reward tradeoff in finance suggests that the potential for higher returns comes with a higher level of risk. This means that as the investment risk increases, the potential for reward also increases. However, it's important to note that higher risk doesn't guarantee higher returns; it merely provides the potential for higher returns. The actual outcome may still result in a loss. This is because the risk in investments is the uncertainty that an investment's actual future returns will deviate from its expected returns. The greater the degree of risk, the greater the possible deviation from the expected return, and thus the greater the range of possible outcomes, including both losses and gains. Therefore, investors who are willing to accept higher levels of risk do so with the expectation of achieving higher potential returns.
A is incorrect because, typically, risk and potential reward are directly related, not inversely. If you're taking on more risk, it's usually because you expect the possibility of a higher return to compensate for that risk. This doesn't guarantee a higher return, but the potential is greater.
B is incorrect because it contradicts the basic principle of the risk-reward tradeoff. Lower-risk investments generally yield lower potential returns. For example, a government bond (low risk) typically offers lower returns than investing in a new tech startup (high risk).
D is incorrect because it suggests there is no general correlation between risk and reward in investments, and it boils down to individual assets. While the specific level of risk and potential reward can vary between different financial products, the general principle that higher risk is associated with a higher potential for reward holds true across virtually all types of investments.
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Q.9 The concept of risk and reward is a fundamental principle that governs investment decisions. This principle suggests a certain relationship between the level of risk an investor is willing to take and the potential reward they might receive. Which of the following statements accurately describes this relationship between investment risk and potential reward?
A
As the investment risk increases, the reward decreases.
B
As the investment risk decreases, the reward increases.
C
As the investment risk increases, the potential for reward increases.
D
The relation between investment risk and reward depends on the financial product.