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
Eye Field - Vertebrate Eye The development of eyes starts with evagination of the lateral wall of the forebrain. one on each side, which make the optic vesicles. By vital dye

how i can get enough money with out doing any works ????????????

Question: (a) Describe the process for assigning composite and component ratings under the CAMEL rating system. (b) The IMF has developed some indicators to identify early

Credit Standards A firm may follow a stringent or a lenient credit policy. The firm subsequent of a lenient credit policy tends to sell on credit to customers on extremely lib

Source of Finance for the Sole Proprietor Some sources of capital---Discuss a) Savings b) Assistance from friends or relatives c) Proceeds from sale of assets d) Ba

International Data Systems information on revenue and costs is only relevant up to a sales volume of 100,000 units. After 100,000 units, the market becomes saturated and the price

Differences between Equity Finance and Preference Dissimilarity between Equity Finance and Preference are as follows:   Ordinary share capital

What is the need for documents in international business? Substantiate your answer with suitable examples.

Types of Stock Markets 1. Over the Counter or OTC and Organised Exchange market This is whereas the selling and buying of securities is done through sellers and buyers ar

Example of Debt Finance An example: Interest = 10% tax rate = 30% The effective cost of debt (interest) = Interest rate (1 - T) = 10%(1-0.30) = 7% Consider comp