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Evaluating an Investment Strategy
A friend tells you they are planning to invest all their savings into a single, newly-launched technology startup because it has a projected annual return of 25%, which is much higher than the 3% offered by a diversified market fund. Critically evaluate your friend's investment strategy. In your evaluation, explain the fundamental reason why an asset with such a high projected return also carries significant uncertainty, and why simply choosing the highest projected return might not be a sound decision.
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Economics
Economy
Introduction to Macroeconomics Course
Ch.6 The financial sector: Debt, money, and financial markets - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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Evaluation in Bloom's Taxonomy
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Risk Premium
Evaluating Investment Options
An investor is considering two different assets. Asset A is a government bond with a very low chance of default and offers a 2% expected annual return. Asset B is a stock in a new technology company with a much higher degree of uncertainty about its future performance, but it offers a 10% expected annual return. Based on the principles of investment, which statement best analyzes the relationship between these two assets?
Justifying Higher Returns for Risky Assets
A new startup company offers bonds with an expected return of 12%, while a well-established government offers bonds with an expected return of 4%. Which of the following statements provides the most accurate economic justification for this difference in expected returns?
An asset with a high degree of uncertainty regarding its future value is guaranteed to provide a higher actual return than a safer asset, as this is the necessary payment for the risk involved.
Evaluating an Investment Strategy
Match each investment asset with the description that best explains its expected rate of return, based on the principle that investors require greater potential compensation for taking on more uncertainty.
An investment portfolio manager is analyzing two potential assets for a client. Asset X has a history of fluctuating significantly in value but has an average projected return of 9% per year. Asset Y is known for its stability and has a projected return of 3% per year. Which statement best explains the economic principle underlying the difference in their projected returns?
If a highly unpredictable investment offered the same expected rate of return as a very stable and secure investment, what would be the most likely outcome in the market?
An investment advisor tells their client, 'You should invest in this new tech startup instead of government bonds. Because the startup is much riskier, it is required to provide a higher actual profit. You are certain to make more money with the startup to make up for the risk.' Which statement best evaluates the advisor's reasoning?