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← Risk and Return: The Fundamental Trade-off
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Question
Why do higher-risk investments tend to offer higher expected returns in a competitive market?
1
Regulators require higher returns to compensate for the additional administrative burden of risky assets
2
Higher risk assets carry lower taxes, which effectively boosts their after-tax return
3
If higher-risk assets did not offer higher expected returns, rational investors would sell them until prices fell enough to restore compensation for the additional risk
4
Higher volatility reduces the number of buyers, and fewer buyers drive prices lower and yields higher automatically
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