What is objective of risk and return analysis?

Answer 1

The concept of risk and return analysis is integral to the process of investing and finance. All financial decisions invlove some risk. You may expect to get a return of 15% per annum in your investment but the risk of "not able to achieve 15% return" will always be there.

Return is simply a reward for investing as all investing involves some risk.

The greater the risk, the greater the return expected.

The objective of risk and return analysis is to maximize the return by creating a balance of risk. For example, in case of working capital management, the less inventory you keep, the higher the expected return as less of your money is locked as asset.; but you also have a increased risk of running out of raw material when you actually need it for production or maintenance. Which means you loose sale. Thus all companies tries very hard to maintain an minimum investory as possible without effecting smooth production. This is a very commong expample of risk return trade-off

In case of an investment in shares/stocks, I as an investor accept to get a better return than fixed deposits but I am also ready to take risk of loosing my money in Stock Market.

Hence important is to understand how much risk you can take and invest accordingly.

A lay man shall ask himself:

1. How much money I can put in stocks today, and even if I loose this money it will not affect my way of life? If your answer is $100 it means you are ready to take a risk for $100.
2. How much return I expect from stock in next one year? if you want to make 12% per annum your expectation is real and you are taking a risk of $100 dollars to make 12% per annum.

Bu doing this a lay man is calculating his risks and extimating a return on investment.