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Investment Discussion

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You work for a large investment firm and recently wrote a position article on your firm's approach to investing for the small investor, titled "Investing is for the little guy". The article now appears on your company's website. It has, interestingly enough, generated e-mailed responses from potential clients and your firm is asking you to address some of their questions for a Frequently Asked Questions (FAQ) segment that will be posted to the site soon.

Specifically, some of the respondents have compared investing in the stock market as a no win situation and only the institutional investors can win. These respondents would like a response that further clarifies your firm's position regarding risk in light of these types of statements.

In your response, your company has asked that you address these questions building upon the risk-return concepts you identified in the position piece you wrote for the firm.

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Frequently Asked Questions (FAQ) segment on risk-return and Investment concepts for small investor:

What is return?
Return is income earned on the investments. In stocks income is earned either by way of dividend or capital gain.

What is risk?

Risk is the uncertainty that you may not earn your expected return on your investments. For example, you may expect to earn 20% on your stock mutual fund every year. But your actual rate of return may be much lower.

For example, the S&P 500 index averaged yearly gains of about 20% for the five years that ended in 1999. In 2000, however, the index declined more than 9%. Bonds, meanwhile, performed better than stocks for the first since 1994.

What is risk -return trade off?
The risk-return trade-off requires that you accept more risk in exchange for the chance to earn a higher rate of return. If unwilling, you should expect to earn a lower return. Conservative investors, for example, are less willing to lose 10% of their investments in exchange for the chance to earn a higher rate of return. Aggressive investors, on the other hand, are willing to accept this risk in exchange for the chance to earn higher returns

Rate of return: An investor who is unwilling to accept a higher degree of investment risk in exchange for a chance to earn a higher rate of return. Investment risk is the volatility of investment returns. A basic investing principle states that a higher degree of investment risk is required to earn a potential higher rate of return

What are different types of risk?
Ans:
Major types of risk include:
Investment risk. Investment risk is the chance that your investment value will fall. Standard deviation is commonly used to measure investment risk. It shows a stock or bond's volatility, or the tendency of its price to move up and down from its average. As standard deviation increases, so does investment risk?

Market risk. Market risk is the chance that the entire market where your investment trades will fall in value. Market risk cannot be diversified. Securities are exposed to market risk including recessions, wars, structural changes in the economy, tax law changes, even changes ...

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