Which is true about the relationship between Risk and Return

Which is true about the relationship between Risk and Return?

a) When risk increases the expected return will decrease

b) When risk decreases the expected return will decrease

c) When risk increases the expected return should not change

d) There is no relationship between risk and expected return

Solution

Answer is statement 2.

Based on basic financial principles, risk and return are directly related to each other. For each additional risk that an investor takes, he will demand additional return, in order to be compensated for the higher risk.

So, higher risk would imply higher expected return.

Similarly, if the risk decreases, expected return associated would also decrease.