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The risk–return spectrum (also called the risk–return tradeoff or risk–reward) is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment. The more return sought, the more risk that must be undertaken.

Sharpe Ratio

All this can be visualised by plotting expected return on the vertical axis against risk (represented by standard deviation upon that expected return) on the horizontal axis. This line starts at the risk-free rate and rises as risk rises. The line will tend to be straight, and will be straight at equilibrium - see discussion below on domination.

For any particular investment type, the line drawn from the risk-free rate on the vertical axis to the risk-return point for that investment has a slope called the Sharpe ratio.

Short-term loans to good government bodies

On the lowest end is short-dated loans to government and government-guaranteed entities (usually semi-independent government departments). The lowest of all is the risk-free rate of return. The risk-free rate has zero risk (most modern major governments will inflate and monetise their debts rather than default upon them), but the return is positive because there is still both the time-preference and inflation premium components of minimum expected rates of return that must be met or exceeded if the funding is to be forthcoming from providers. The risk-free rate is commonly approximated by the return paid upon 30-day or their equivalent, but in reality that rate has more to do with the monetary policy of that country's central bank than the market supply conditions for equilibrium - see discussion below on domination.

For any particular investment type, the line drawn from the risk-free rate on the vertical axis to the risk-return point for that investment has a slope called the Sharpe ratio.

Short-term loans to good government bodies

On the lowest end is short-dated loans to government and government-guaranteed entities (usual

For any particular investment type, the line drawn from the risk-free rate on the vertical axis to the risk-return point for that investment has a slope called the Sharpe ratio.

On the lowest end is short-dated loans to government and government-guaranteed entities (usually semi-independent government departments). The lowest of all is the risk-free rate of return. The risk-free rate has zero risk (most modern major governments will inflate and monetise their debts rather than default upon them), but the return is positive because there is still both the time-preference and inflation premium components of minimum expected rates of return that must be met or exceeded if the funding is to be forthcoming from providers. The risk-free rate is commonly approximated by the return paid upon 30-day or their equivalent, but in reality that rate has more to do with the monetary policy of that country's central bank than the market supply conditions for credit.

Mid- and long-term loans to good government bodies

After the returns upon all classes of investment-grade debt come the returns on speculative-grade high-yield debt (also known derisively as junk bonds). These may come from mid and low rated corporations, and less politically stable governments.

Equity

Equity returns are the profits earned by businesses after interest and tax. Even the equity returns on the highest rated corporations are notably risky. Small-cap stocks are generally riskier than large-cap; companies that primarily service governments, or provide basic consumer goods such as food or utilities, tend to be less volatile than those in other industries. Note that since stocks tend to rise when corporate bonds fall and vice versa, a portfolio containing a small percentage of stocks can be less risky than one containing only debts.

Options and futures