1 Risk and Return Student's Name Institution Course Instructor Date
2 Risk and Return 1. Explain the difference between required rate of return and expected rate of return. If they are different at a specific point in time, what does it mean? The required rate of return is the rate of return an investor requires in order to put up with the dangers of stock trading. It is used to calculate an estimate of how much money can be made from an investment. Higher returns can be expected from investments that carry a higher degree of risk. Expected rate of return is a projection of future gains or losses from an investment. It is an essential part of financial theory and commercial practice since it shows the expected gain or loss on an investment (Dilmore & Wilson, 1992). It aids in the growth of economic theories like Modern Portfolio Theory (MPT) and pricing models like the Black-Scholes model. If the projected rate of return exceeds the required rate of return, the investment may be rewarding and offer a chance to earn more than the investor's minimum expectations. The situation may suggest a profitable investment.An investment may fail to satisfy the investor's minimal return expectations if the expected rate of return is lower than the needed rate of return, taking into account the level of risk involved. This may lead the investor to consider other investments. A potential investment may have an expected rate of return higher than the needed rate, whereas a lower expected rate signals a less enticing option. 2. What is the difference between an expected return and a total holding period return? An investor's expected return is the amount of money they anticipate making or losing on their investment. Adding the sum of each potential outcome times its corresponding probability yields the answer. Investors can use this technique to estimate the average return based on probabilities, taking into account the varying projected rates of return on the investment. Conversely, the total holding period return is the sum of any returns accrued from owning a
3 portfolio or asset for a given time period. All investment income, expenses, and gains or losses during the time frame in question are factored in. The total holding period return is a measure of the asset's or portfolio's overall performance over the specified time horizon and is typically stated as a percentage. 3. How does investing in more than one asset reduce risk through diversification? Having holdings in a number of different markets and sectors spread out across your portfolio helps spread your investment risk. Having assets with varying responses to events and market fluctuations is one way to increase the likelihood of a positive return. Those with a longer time horizon and a low tolerance for financial loss are the primary target audience (Roberts & Schermer, 2011). For example, consider the impact on your portfolio if you owned shares of an airline and then learned that several of their planes had experienced mechanical failures. For this reason, it may be advantageous to have financial stakes in non-air transportation choices, such as railroads or a rental car service.