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Investments are based on the belief that the rate of return justifies or compensates the investor for the risk associated with that particular investment. The risk associated with this investment is the chance that a loss will be incurred. Or, to put it another way, the greater the chance of a loss the riskier the investment. Therefore, some statistical measures of the risk involved with an investment are necessary before the investment is made.
Address one of the following prompts in a concise but thorough manner.
What is the Expected Rate of Return on investment and what does it tell us about the probability of the risk involved with a particular investment?
In terms of risk, what are the advantages (and/or disadvantages) of a well-diversified portfolio? 400-500 words
The Expected Rate of Return (ERR) on an investment is a measure of what the investor expects to receive from that investment over a given period of time, with all possible outcomes taken into account. It is calculated by taking the weighted average return for all potential returns associated with the investment, where the weighting factor is determined by the probability of each outcome occurring.
In this way, ERR provides investors with an indication of how much they can expect to make on their investments and how likely it is that these expected returns will be achieved. On one hand, if an ERR is high then it indicates that there is a higher chance of making more money than was initially invested. Conversely, if ERR is low then there may be greater risk associated with achieving anything close to the expected return.
A well-diversified portfolio offers numerous advantages in terms of reducing risk through diversification and increasing the potential for better overall returns. By holding multiple asset classes across different markets and sectors which have varying degrees of correlation – meaning they move up or down independently – investors can benefit from decreased volatility as opposed to having concentrated exposure in any particular area. This means they are able to enjoy smoother overall performance while still often receiving higher total returns due to having exposure across diverse sectors (and thus less downside risk). Additionally, diversification reduces specific risks like currency fluctuations or sector-specific events which could potentially cause large losses in any single portion of a portfolio.
While diversification carries many benefits for mitigating some risks involved when investing, it does not guarantee against loss nor does it eliminate all market volatility entirely since assets within a portfolio still may move together during times such as economic downturns or bear markets when most asset classes suffer from negative performance simultaneously which can lead to larger-than-normal drawdowns in value compared to non-diversified portfolios. Therefore, although diversification helps reduce some types of risk associated with investing; it cannot protect against every type or magnitude thereof so careful consideration should always be made before committing funds towards any form/amount/kinds/etc…of investments