The Rocky Marriage of Risk and Return

Abstract

This chapter introduces a topic that is perhaps most valuable in the investments arena. However, this text has made a conscious effort to point out that financial assets must be viewed from multiple angles. Also, keep in mind that an investment can be any number of things, particularly in corporate finance. So, although we will focus on financial investments to illustrate the points of interest throughout the chapter, keep in mind the materials will readily apply to physical investments as well. Thus, it is of particular interest to understand how this material fits into the overall context of capital structure and capital budgeting. This chapter will be roughly divided into two concepts, both with the same end objective. The first examines a data-driven method of determining the relationship between risk and return. The second concept examines the risk/return relationship on a more theoretical basis.