Army Institute of Business Administration (AIBA), Savar
Assignment -01
ON
“How the knowledge of risk return trade off can influence
investment decisions”
Course name- Investment analysis and portfolio Management
Course code-FIN5202
Submitted By- Submitted to-
Shafayet Sarker Lec. Dar-un-Nayem Aurnob,
ID: 24230407012 MBA, BBA
Army Institute of Business Administration (Army
IBA), Savar
Date of Submission: 7th November, 2024
Risk-return trade off knowledge can influence my investment decisions, explanations are given
below-
1. Defining the Risk-Return Trade-off
Risk: The uncertainty or potential financial loss associated with an investment.
Return: The profit or yield an investor expects from an investment.
Trade-off Principle: Generally, the higher the potential return of an investment, the higher the
risk associated with it. Investors must choose between maximizing returns and minimizing risks.
2. Types of Investors Based on Risk Tolerance
• Risk-Averse Investors:
➢ Prefer low-risk, stable investments like bonds or savings accounts.
➢ Typically accept lower returns to avoid potential losses.
Example: Retirees may prefer fixed-income securities for stability.
• Risk-Seeking Investors:
➢ Willing to take on higher-risk investments for the possibility of higher returns.
➢ Likely to invest in stocks, real estate, or even speculative assets like cryptocurrency.
Example: Younger investors with a long-term horizon might choose growth stocks despite
market volatility.
3. Influence of Risk-Return Trade-off on Investment Choices
• Low-Risk, Low-Return Investments:
➢ Include savings accounts, government bonds, and CDs.
➢ Suitable for risk-averse investors who prioritize capital preservation over growth.
Example: A conservative investor may choose U.S. Treasury bonds, which are considered
low-risk but offer modest returns.
• Moderate-Risk, Moderate-Return Investments:
➢ Include corporate bonds, mutual funds, and dividend-paying stocks.
➢ Balances growth with some level of risk, attracting investors seeking steady returns with
moderate risk.
Example: A middle-aged investor might invest in a diversified mutual fund for moderate
returns and controlled risk exposure.
• High-Risk, High-Return Investments:
➢ Include stocks, real estate, venture capital, and cryptocurrencies.
➢ Potentially high returns but come with significant volatility.
Example: An aggressive investor with high risk tolerance may invest in technology stocks
or cryptocurrency for potentially high gains despite the risk.
4. Portfolio Diversification as a Tool for Managing Risk
• Diversification Strategy:
➢ Spreads investments across asset classes to balance risk.
➢ Reduces the impact of a poor-performing asset on the overall portfolio.
Example: A well-diversified portfolio might include a mix of stocks, bonds, and real estate
to manage risk effectively.
• Impact of the Risk-Return Trade-off on Diversification:
Investors often allocate more to high-risk, high-return assets when younger, and shift to safer
investments as they approach retirement.
Example: A 30-year-old might allocate 70% to stocks and 30% to bonds, while a 60-year-old
might reverse this allocation to preserve capital.
