Business Finance

Quarter 4 – Week 2:
Risk-Return Trade Off
Business Finance – Grade 12
Alternative Delivery Mode
Quarter 4 – Module 8: Risk-Return Trade Off
First Edition, 2020

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Business Finance
Quarter 4 – Week 2:
Risk-Return Trade Off
Introductory Message
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Thank you.
 What I Need to Know

Risk-Return Trade Off

This lesson is about risk management and how a business can gain from
taking risks.

At the end of the module, you should be able to explain the risk-return trade
off (ABM_BF12-IIIg-h-22).

Specifically, you are going to:

a. define risk, return and risk-return trade off;

b. differentiate investment risks and risk tolerance; and
c. explain the importance of portfolio management.

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 What I Know

What are the risks in business? What does return mean? Would you gain from
taking risks? These questions will be answered in this lesson. For you to explain the
risk-return trade off, here are some terms you need to understand.

Directions: Select the letter of the correct answer. Write your answers on a separate
sheet of paper.

1. Which statement is true about risks?

A. Risks are present in all types of investment.
B. An investor can select investments with minimum risks.
C. Both A and B
D. None of the above

2. What kind of investment is said to have higher returns?

A. low risk
B. risk free
C. high risk
D. average risk

3. Which is true about risk-return trade off?

A. An investor will never accept losses in an investment.
B. The riskier the investment is, the more an investor expects a high
return or profit.
C. It is the concept of low-risk-high-return.
D. All of the above

4. Which of the following is a conservative type of investor?

A. invests all resources in a time deposit
B. invests all resources in the stock market
C. invests all resources in the online selling business
D. does not invest at all

5. What is investment diversification?

A. investments with high profit
B. investments with no risks
C. investments from different profit-making activities
D. investments with low risks

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 Lesson

1 Risk-Return Trade Off

Investing is an efficient and effective way to use personal or business funds.

These funds, to be considered an investment, need to be engaged in profitable
activities, otherwise, it will not be investing but mere expenditure. However, there
are certain questions that one may consider before considering an
investment activity.

a. Why is there a need for investment?

b. How much will it cost? How much funds is the investor willing to put into this
investment?
c. How big are the chances of gaining or losing from this investment?
d. How long will the investor make hold of this investment?

Investment can be considered as funds that can either multiply or incur a

loss. These questions will help business owners in deciding and choosing the
investment with the greatest possible return or gain.
Investment risks are uncertainties or chances that the outcomes of
investments are different from what is expected or projected.

Some examples of investment risks are (Ontario Securities Commission, 2019):

1. Market risk is the uncertainty due to economic development or factors
that affect the entire market.
2. Liquidity risk is the chance that an investor is unable to sell an
investment due to change in price. The investor may need to accept a lower
selling price.
3. Concentration risk refers to the concentration of loss that can be incurred
due to a lack of diversification.
4. Credit risk is the risk that money invested in a government bond may be
uncollectible.
5. Reinvestment risk refers to the risk of loss from shifting from one
investment to another.
6. Inflation risk is the risk that an investment may not be able to sustain its
purchasing power due to inflation.
7. Horizon risk is the risk that an investment may be stopped or pulled-out
due to unforeseen events (loss of job).
8. Longevity risk is the risk that a person will live too long and may outlive
his/her investment/savings.
9. Foreign investment risks are individual market risks that may affect
investments from different countries.

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 ???

Famous Franchise New Store

Php 2,500,000.00 Php 1,000,000.00

Example: An investor is choosing between acquiring a famous franchise for

Php 2.5 million and establishing her own convenience store at Php 1 million. The
risks of acquiring the famous franchise are high because it costs more than
establishing a store from scratch. If each business is under the same condition, a
down economy for example, an investor may lose as much as Php 2.5 million if
franchising is chosen.

Investment returns are the expected or projected profits to receive from an

investment.

Famous Franchise
Php 2,500,000.00

Example: Suppose that the chosen investment is the franchise. Upon analysis,
franchising will give the greatest possible return primarily because of the established
market strengths of a well-known business name. Continuous support can also be
provided by the parent company. The weight of handling negative economic impacts
will be well distributed if not avoided. Promotion, branding, and goodwill are also
basically provided and will no longer be a problem to start with. Therefore, higher
profits are expected, given these advantages.

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 Risks Accepted!

Investment Risks Investment Returns

Risk-return Trade Off

In this regard, risk and return are directly related to an investment
opportunity. In business, there is a principle that lower risk tends to give lower
returns while higher risk tends to give higher returns. Therefore, in a risk-return trade
off, an investment will yield a higher return only if the investor accepts a higher risk
or possibility of losses (Chen, 2020).
However, not all investors are willing to accept risk the moment it is presented
to them. Investors have different levels of acceptance because it is primarily driven
by the availability of resources while balancing the advantages and disadvantages of
investment opportunities. This level of acceptance is called risk tolerance (Twin,
2020) and is classified into conservative, moderate, and aggressive.

Conservative Risk Tolerance is a characteristic of an investor whose

willingness in accepting risks is very low. This investor will expect to gain profit, with
little to no disadvantage to them.

Conservative Risk Tolerance

Resources Low Risks Low Returns

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 Moderate Risk Tolerance is a characteristic of an investor who is willing to
put average resources and accept some risks. This investor will expect to gain above-
average profit, while enduring little disadvantages. This type of investor is more likely
to pull-out an investment (if applicable) whenever risks are uncontrollable.

Moderate Risk Tolerance

Resources Medium Risks Medium Returns

Aggressive Risk Tolerance is a characteristic of an investor who is willing to

put more resources and accept maximum risks on high-quality investment with high
expectation of return. This investor has great knowledge about the industry and is
willing to keep the investment at a longer holding period until investments create the
highest possible return but is prepared for the worst - losing the entire investment.

Aggressive Risk Tolerance

Resources High Risks High Returns

Portfolio Management

Portfolio management is the planning of investment opportunities based on

the risk tolerance of an investor, to meet the financial objectives at a given time
frame. On a more technical term, portfolio management is used in investment
discussions about stocks, bonds, time deposits, and other money
market investments.

Investors have the principle of “putting eggs in different baskets”. This is called
an investment diversification. In cases where the investor has stagnant or excess
resources, they engage in different investing activities to gain profit. It can be used
to put up a store, offer credit to borrowers, finance a profit-making project, or invest
in the stock market, time deposit, bonds, and foreign exchange. These “baskets” are
called portfolios. Each portfolio is different in purpose, amount, risks, returns, and
time frame. A wise investor who is maintaining two or more accounts should keep
investment portfolios to keep track of the growth or losses in each investment.

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 Resources

Investment 1 Investment 2 Investment 3 Investment 4

Investment Diversification

By putting resources into different baskets (diversification), it will reduce or

spread the risks of losing all investments. In this example, the investor funds four
investment portfolios. If investment 3 falls, somehow, the risk of losing all investment
is low. But this should not mean that one will let go of investment 3 without further
financial and risk analysis.

It is important that investments have clear financial objectives, no matter how

big or small the investment is. In investing, time should be the investor’s ally because
time is one key for funds to grow. Harvesting too early may be more damaging to
your finances and objectives. More than anything else, getting an investment
requires continuous market study to enjoy substantial to maximum profits.

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 What’s In

Directions: In your own words, define the following business concepts. Write your
answers on a separate sheet of paper. (2 to 3 sentences)

1. Investment Risks

2. Investment Returns or Gains

3. Risk-return Trade off

Scoring Rubrics:

The concept is well defined and discussed comprehensively

9-10 pts
through giving an example or illustration.
The concept is well defined and discussed but without
6-8 pts
example or illustration.
The concept is defined and discussed ambiguously but is
3-5 pts
acceptable.
The concept is not accurately defined, and the explanation is
1-2 pts
far from the concept or main idea.

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 What’s New

Directions: Identify the type of investment risk best demonstrated in each of the
following situations. Choose your answer in the box below. Write your
answers on a separate sheet of paper.

Market Risk Liquidity Risk Concentration Risk

Inflation Risk Horizon Risk
Credit Risk Reinvestment Risk

1. Many businesses are economically affected by COVID-19 pandemic.

2. An investment was originally priced at Php 200,000.00, but due to unit price
change, it has a fair market value of Php 150,000.00 and may continue to go
down. The investor no longer has the intention of keeping it and wants to sell
it at Php 140,000.00.

3. A person put money on a time deposit and accumulated the agreed interest.
However, at maturity, the value seems to have no significant effect on
purchasing power due to inflation.

4. Based on a performance record, a government bond can give a maximum of

5% interest on investments. However, upon maturity, the interest is only 2%.

5. An investor manages two types of investment portfolios with distribution of

70% and 30% from his resources. However, the portfolio with 70% investment
is not doing good in the market.

Notes to the Teacher / Facilitator

To better understand the investment risk and return, cite a video,
article or a true story of successful individuals investing in
different platforms. Through this, students can understand that
all investments have risk, yet success will follow if people know
how to control these risks.

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 What is It

Directions: Analyze the case and answer the question that follow. Write your
answers on a separate sheet of paper.

The Online Business Fad

Filipinos are the number one social media user. The "Digital 2019: Global
Digital Overview" showed stats that Filipinos spend an average of 10 hours and 2
minutes on the internet via any device (ABS-CBN News 2019). In addition, during
the pandemic, social media is even more functional to sellers and convenient to
buyers. Before, varieties of products sold online are apparels, toiletries, and seasonal
delicacies. Recently, the fad of online business has come into a wider spectrum of
products to choose from.

1. What type of risk/s can an online seller experience? Explain. (2 to 3 sentences)

2. Discuss the risk-return trade-off for an online seller. (2 to 3 sentences)

Scoring Rubrics:

The concept is well defined and discussed comprehensively

9-10 pts
through giving an example or illustration.
The concept is well defined and discussed but without
6-8 pts
example or illustration.
The concept is defined and discussed ambiguously but is
3-5 pts
acceptable.
The concept is not accurately defined, and the explanation is
1-2 pts
far from the concept or main idea.

10
 What’s More

Directions: Analyze the case and answer the questions that follow. Write your
answers on a separate sheet of paper.

Stock Market: Is it Affordable?

Stocks are shares of ownership in a corporation. A corporation can sell stocks

publicly to encourage more investors. The Philippines Stock Exchange (PSE) is the
market where these corporations sell stocks. Once an investor buys stocks from a
corporation, he/she becomes a part-owner of that corporation. The earnings from
stock trading are in the form of dividends (percent share in the income of the
corporation) and stock price appreciation (increase in the price of the stock).

Investors buy shares of a corporation to increase capitalization because the

stocks can shoot up prices over time from how much it was originally bought. For
example, an investor buys 10,000 shares from a well-known construction firm for
Php 100,000.00 at Php 10.00 at the current market price. After 20 years, the stock
price becomes Php 50.00 and the value of the investment is Php 500,000.00. This
scenario is the usual motivation for an investor to engage in the stock market.

Blue Chips companies are big companies that are the safest to invest on. It is
seen on the website of Philippine Stocks Exchange through PSE Edge
(https://edge.pse.com.ph/companyDirectory/form.do).

Let us assume these examples as Blue Chips companies.

1. Alana Land, Inc. Php 31.60

2. BPO Unibank, Inc. 85.30
3. Bank of the Filipinos 64.60
4. Jolli Foods Corporation 128.40
5. Metropolis Bank and Trust Company 33.65
6. Puresilver Price Club, Inc. 47.65
7. San Miguelito Corporation 96.40
8. Universal Robinhood Corporation 124.50

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 If the risk of loss is 25% while the chance of return is 40%, and given
that you have a Php 100,000.00 amount for investment, which of the
mentioned blue chips will you buy? Discuss your risk tolerance as an investor
and explain the risk-return trade-off of your chosen investment. (5 sentences)

Scoring Rubrics:

The concept is well defined and discussed comprehensively

9-10 pts
through giving an example or illustration.
The concept is well defined and discussed but without
6-8 pts
example or illustration.
The concept is defined and discussed ambiguously but is
3-5 pts
acceptable.
The concept is not accurately defined, and the explanation is
1-2 pts
far from the concept or main idea.

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 What I Have Learned

Directions: Answer the question below. Write your explanation on a separate

sheet of paper.

How can a risk-return trade-off concept be helpful to an investor?

(5 sentences)

Scoring Rubrics:

The concept is well defined and discussed comprehensively

9-10 pts
through giving an example or illustration.
The concept is well defined and discussed but without
6-8 pts
example or illustration.
The concept is defined and discussed ambiguously but is
3-5 pts
acceptable.
The concept is not accurately defined, and the explanation is
1-2 pts
far from the concept or main idea.

13
 What I Can Do

Stressed Economy

Directions: Cut and paste a news article containing the effects of pandemic to a
business. Paste the article on a separate sheet of paper.

Questions:

1. What kind of business/industry is affected?

2. What investment risk/s are involved? Explain. (5 sentences)

3. Suggest at least one (1) strategy on how they can improve operations even
under community quarantine.

Scoring Rubrics:

The concept is well defined and discussed comprehensively

9-10 pts
through giving an example or illustration.
The concept is well defined and discussed but without
6-8 pts
example or illustration.
The concept is defined and discussed ambiguously but is
3-5 pts
acceptable.
The concept is not accurately defined, and the explanation is
1-2 pts
far from the concept or main idea.

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 Assessment

Directions: A. Select the letter of the best answer. Write your answers on a separate
sheet of paper.

1. Which is a feasible investment risk?

A. Mark promises investors that he can double their money in 10 years.
B. Mark promises investors that no loss will be incurred in 10 years.
C. Mark does not promise that the investment would grow as much as 10%
but will depend on market situations.
D. All the above

2. Which situation shows an investment return?

A. Sasha invests Php 100,000.00 in a cooperative and gets Php 101,000.00
after a year.
B. Sasha saves Php 100,000.00 in a bank and gets Php 200.00 interest
per month.
C. Sasha saves Php 1,000.00 in a coin bank per month.
D. Sasha plans to establish a sari-sari store with her Php 100,000.00.

3. Danny B, is a business owner. For 5 years in the business, he saved

Php 500,000.00 in his bank account. Danny invests a part of this money into
a government bond with low risk but low return. What type of risk tolerance
is shown?
A. conservative risk tolerance
B. moderate risk tolerance
C. aggressive risk tolerance
D. low tolerance

4. Which of the following situations shows portfolio management?

A. Mr. Benjie saves money in a coin bank. He owns 10 coin banks overall.
B. Mr. Ali gets Php 50,000.00 from bonus, Php 10,000.00 from commission
and Php 5,000.00 from his salary.
C. Ms. Ivee won Php 1,000,000.00 from lottery. She saved Php 500,000.00 in
a savings account, put Php 300,000.00 in a time deposit and put up a
store for Php 200,000.00.
D. Ms. Rowena has 4 bank accounts; all are payroll accounts. She has been
working four jobs to feed her family.

15
 5. Local prices of farm goods are negatively affected by high importation. Due to
this, farmers have no choice but to accept the lowest market prices for their
highly perishable products. What risk is involved in the situation?
A. market risk
B. inflation risk
C. credit risk
D. reinvestment risk

Directions: B. Identify the terms being described. Choose your answers from the
box below.

Market Risk Investment Returns

Investment Risk Horizon Risk
Concentration Risk Investment Diversification
Reinvestment Risk Foreign Risk
Moderate Risk Tolerance Risk-Return Trade Off

1. It refers to the risk of loss from shifting from one investment to another.
2. It is the uncertainty due to economic development or factors that affect the
entire market.
3. These are individual market risks that may affect investments from different
countries.
4. This refers to the concentration of loss that can be incurred due to lack of
diversification.
5. It is the risk that an investment may be stopped or pulled-out due to
unforeseen events (loss of job).
6. These are uncertainties or chances that the outcomes of investments are
different from what is expected or projected.
7. These are the expected or projected profits to be received from an investment.
8. It is a principle that lower risk tends to give lower returns while higher risk
tends to give a higher return.
9. It is a characteristic of an investor who is willing to put average resources and
accept some risks.
10. It is the principle of “putting eggs in different baskets”.

16
 Additional Activities

Online Seller’s Story

Directions: Interview an online seller. Narrate his/her story as a business owner.

Based on this story, discuss his/her risk tolerance and the risk-return trade-off of
the business. (10 sentences)

Scoring Rubrics:

The concept is well defined and discussed comprehensively

9-10 pts
through giving an example or illustration.
The concept is well defined and discussed but without
6-8 pts
example or illustration.
The concept is defined and discussed ambiguously but is
3-5 pts
acceptable.
The concept is not accurately defined, and the explanation is
1-2 pts
far from the concept or main idea.

17