School

Ohio State University **We aren't endorsed by this school

Course

AGED 10

Subject

Finance

Date

Oct 31, 2023

Pages

4

Uploaded by DeaconSnowSeaLion27 on coursehero.com

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Risk and Return
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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

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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.

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