SIE practice questioneasyRisk and Return Relationship
The general relationship between risk and return in investing is:
- AHigher risk investments always guarantee higher returns
- BHigher potential returns generally require accepting higher levels of risk✓ Correct answer
- CLower risk investments always provide the highest returns
- DRisk and return are unrelated
Explanation
Why B — Higher potential returns generally require accepting higher levels of risk
There is a positive relationship between risk and potential return — investors who take on more risk generally expect to be compensated with higher potential returns. However, this is not guaranteed (A is wrong). Higher risk means both higher potential returns AND higher potential losses. T-bills (low risk, low return) vs. small-cap stocks (high risk, high potential return) illustrate this relationship.
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