Stock M N O P Standard deviation 12% 20% 15% 30% 1. Which stock is the riskest? 2. Based on the risk-return tradeoff, which stock should provide the highest 3. If stock O provides a higher return than stock P, what should happen?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Below are standard deviations of four stocks: M, N, O and P.
| Stock | M | N | O | P |
| Standard deviation | 12% | 20% | 15% | 30% |
1. Which stock is the riskest?
2. Based on the risk-return tradeoff, which stock should provide the highest
3. If stock O provides a higher return than stock P, what should happen?
The relationship between the return and risk is direct.
When risk of stock is more, return provided from the stock is also high.
When risk of stock is less, return provided from the stock is also less.
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