Question 1

Return is what one makes in an investment while risk is the possibility that the actual returns will be less than expected. Risk means there is the possibility of one losing some or all of the investment. The relationship between the two concepts is related through trade off. The risk-return tradeoff is a principle that suggests that the potential returns increases when the risk associated with an investment increases. This means that an investment can lender high returns if the investor is willing to take a higher risk.

However, there is always the misconception of higher risk higher return. The tradeoff suggests that there is the possibility of higher returns when the risk is high but it is not certain. The higher potential returns can also translate to higher potential loses. For investors, making the decision of where to invest is not a simple decision. An investor has to consider the potential risk involved and evaluate the possible returns.

However, to avert the problem of risk, investors usually diversify their portfolio. The portfolio is the range of investments made and diversification means mixing a wide variety of investments in ones portfolio. Diversification ensures that the brisk involved in investing is also diversified. When one investment has low returns, another one has high returns meaning that they balance each other to the expected level of returns.

Diversification is a risk management technique and suggests that a highly diversified portfolio will yield high returns and pose a lower risk than individual investments.  In this case, an investor can expect higher returns and the investment is safer given that the risk involved is lower. The risk-return trade off here does not apply.

Question 2

Beta is a measure of the volatility of stock in relation to the market. An individual stock is measured by how much it deviates from the market beta. A stock that swings more than the market is considered to have a higher beta while a stock that swings less than the market has a lower better. Higher beta stocks have a high risk and have high potential for high returns. The low beta stocks on the other hand have a low risk and low potential returns.

High beta stocks have high volatility than the index they are measured against. They have a high risk. A high beta stock would be invested by investors who have diversified their portfolio. This is because, the risk involved in this kind of stock is very high, and an investor can lose the investment. Thus, the risk has to be averted by diversification. Low beta stocks on the other hand are for investors with individual investment. They have a lower risk and though the returns are expected to be low, the investor has confidence of not losing the investment.

Better is a useful tool in that it enhances the success of an investment. It enables investors to make decisions based on the level of risk involved. The betas used in any case can be different based on the benchmark used. For the measurement of beta, there has to be a benchmark, which is mostly the market beta under which the stock is traded. If the market betas in different markets are different, then the stock beta estimates will be different.

 
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