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- Current section: Introduction
- Learning outcomes
- 1 Risk aversion
- 2 Quantifying risk
- 3 Risk factors
- 4 Discounted cash flow and the net present value rule
- 5 Conclusion
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A fair return on investment is defined as one that compensates the investor for the risk incurred in making the investment – neither more nor less. Conversely, an excess return is one that over-compensates the investor for the risk incurred. Investors want to avoid investments that pay less than a fair return, while borrowers want to avoid paying an excess return. In this unit we shall:
define more precisely what we mean by ‘risk’ in a financial context;
consider how investors react to the presence or threat of risk;
develop a method of quantifying risk mathematically; and
look at the main factors contributing to investment risk in the real world.
Finally, we shall see how the use of the net present value rule enables investors to calculate whether the risks they incur are adequately rewarded.
This material is from our archive and is an adapted extract from Financial strategy (B821) which is no longer taught by The Open University. If you want to study formally with us, you may wish to explore other courses we offer in this.