Risk-return trade-off, Finance Basics

Risk-Return Trade-Off

Most financial decisions comprise alternative courses of action. The choices have different returns and risk.  As like example, must we buy a replacement machine currently or must we wait till next year, must we set the debt-to-assets ratio at 20%, 40% or any another ratio?

The higher the risk on any conclusion, the higher the needed return to compensate for this risk. The relationship between Risk and Return can be expressed follows as:

Required Rate of Return = Risk-free rate + Risk premium.

Risk free rate is compensation for risk premium and time is return for risk of financial actions.  It can be seen such the relationship is direct.

The finance manager should ignore decisions along with unnecessary risk. In creating financing decisions as example, the finance manager must decide whether to finance with equity alone or to use debt as well. The expected return when debt is required is high as the cost of debt is low. Although, since payment of interest on debt is compulsory, so the risk comprises is high. At the other hand the cost of equity is high and thus the return is low. The risk is also low while payment of ordinary dividend is not compulsory. The firm's liquidity decisions will also affect the risk and the return of such firm.

Posted Date: 1/29/2013 2:03:01 AM | Location : United States







Related Discussions:- Risk-return trade-off, Assignment Help, Ask Question on Risk-return trade-off, Get Answer, Expert's Help, Risk-return trade-off Discussions

Write discussion on Risk-return trade-off
Your posts are moderated
Related Questions
mony is differnt from wealth and income

Management of Sole Proprietorship  In sole proprietorship the owner is usually in charge of day to day running of the business. If the business is large he may give some duties

Basic EOQ Model The basic inventory decision model is Economic Order Quantity or called EOQ model. This model is specified via the following equation as: Whereas:Q is

A firm's current ratio is 1.5, and its quick ratio is 1.0. If its current liabilities are $10,000, what are its inventories?   a Current Ratio

finance is divided into _____ and___________

evaluate the source of finance for a business project




Agency Relationship between Auditors and Shareholders Shareholders appoint auditors as per the provisions of Section 159(1)-(6) of the Companies Act. The auditors are believed