Risk and return Essay Example | Topics and Well Written Essays - 1000 words

Risk and return - Essay Example Risk and return are two inversely correlated concepts. A person or a corporation that is risk adverse will not take chances. Lower risk lead to lower returns and higher risk leads to higher returns. The general rule of higher risk leading to higher returns is not set in stone. One of the problems with higher risk is that it can lead to financial catastrophes. For example imagine a person that invests in a penny stock. Penny stocks are considered the most risky of all types of investments. The person decided to invest in penny stock X because he wanted the possibility of earning a higher return. Due to the risk associated with penny stocks the stock ended up defaulting due to the fact that the company went out of business. In this particular case instead of obtaining a higher return the investor ended up losing all his money. 2. Return on investment can be defined as a performance measure used to evaluate the efficiency or to compare the efficiency of a number of different investments (Investopedia, 2011). The formula to calculate return on investment is (Gain from investment –cost of investment) / cost of investment. Companies are always looking to maximize their return on investment. Corporations able to obtain above normal returns on investment are more profitable than the competition. Return on investment can be manipulated when determining projects by changing the expected return of the company. For example a company may establish new financial policy of only accepting projects that achieve a return on investment of 10%. ... The firm lost approximately $15,000 from this project. To me this experienced proved that higher risk can lead to operating losses. 4. The concept of higher risk leading to higher profits is real and in my personal experience it has paid off dividend. When I took my first finance course the professor gave the class a stock market simulation project. I like the project so much that I decided to turn the project into a reality. I opened up an investment account with Scottrade. I invested $2000 to build up a portfolio of stocks. The portfolio was composed of about six stocks including several blue chip stocks and a penny stock. The penny stock was VTSS. I invested about $350 in the VTSS penny stock. After two months the penny stock when up from $0.35 to over $1.50 cents. I made over $1000 dollars from the purchase of the stock. When the class ended I decided to cash out my portfolio. I utilized the earnings from my portfolio to purchase a 1994 Eclipse automobile for my sister. 5. In the corporate world companies have to take risk in order to obtain a return. A risk that a lot of multinational companies are faced with is the decision to penetrate new marketplaces. There are regions in the world that are susceptible to huge risk such as the Middle East. In the Middle East the risks associated with terrorism are very high especially for American companies. Taking chances is a part of the business process. Even when a company has a successful product line the constant changes in the marketplace forces companies to take risk such as introducing new products into the marketplace 6. People take risk in their regular everyday life without even realizing they are doing it. For example a person