The Risk–Return Relationship

  1. Objective 17-4 Describe the risk–return relationship and discuss the use of diversification and asset allocation for investments.

Individual investors have different motivations and personal preferences for safety versus risk. That is why, for example, some individuals and firms invest in stocks while others invest only in bonds. Although all investors anticipate receiving future cash flows, some cash flows are more certain than others. Investors generally expect to receive higher returns for higher uncertainty. They do not generally expect large returns for secure, stable investments such as government-insured bonds. The investment’s time commitment, too, contains an element of risk. While short-term investments ...

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