Principle of Risk & Return

Principle of Risk & Return

     

Figure: Principle of Risk & Return

Risk is the deviation of actual returns from expected return and return is the outcome of any investment (actual return). 

Low levels of uncertainty or risk are associated with low potential returns, whereas high levels of uncertainty or risk are associated with high potential returns. According to the risk-return trade-off, invested money can render higher profits only if the investor is willing to accept the possibility of losses.There is a positive relationship between risk and return.

For example, a higher debt-equity ratio compared to a lower debt-equity ratio may reduce the cost of capital but expose the firm to a greater risk. The principle of risk and return implies a balance is to be made while taking financial decisions.