Risk and reward introduction | Finance & Capital Markets | Khan Academy

Whenever someone talks about investment Will often mention "risk" and "reward" They often appear together This seems to mean the more risk you take The more you get paid indeed so But what I plan to do in this video is Do some more introduction So that you can be more structured and integrated Recognize risks and rewards Suppose we have $1,000 We want to know what we can do with this $1,000 Well, we have an option to deposit it in a deposit account So there is an option We can deposit it in a deposit account In this case, our reward will be… I'll talk about compensation first Well, we can get…, assuming that the annual interest rate is 1% The annual interest rate is 1%. So after a year, I will probably have $1,010 We received 1% of $1,000. So we got some pay What are our risks? So risk…, I write in a different color What is our risk If i deposit money into a deposit account Suppose I deposit into an account with Federal Deposit Insurance (FDIC) insured Let me put it here If you open an account, it should be FDIC insured That means he is insured by the Federal Reserve Bank It means that if the bank fails for some reason, Below a certain amount, the Federal Reserve will protect your money So even if the bank goes down, all the money and everything is lost You still get your deposit back So if you invest and put your money into a FDIC-insured deposit account Your risk is basically zero.

You are guaranteed to get your $1,000 back What's wrong with the bank? So you have no risk But maybe you will say. This kind of risk is great But I want to get more than 1% Let me think about where else i can invest Yes, you can. I will not discuss all investment options I will only give you some concepts of risk and reward Maybe you will say, I can borrow the money Lend to a reputable company. and so… Lend to a reputable company And maybe this company has Many, hundreds of millions of assets And it's been open for hundreds of years It's making money all the time It’s really hard for you to think of a situation This company won't be able to repay the money You actually borrowed money from them by buying their bonds When you buy a company’s debt, you are lending money to that company You should think like this So, if you lend money to this company, your reward will be They pay 6% per annum on your $1,000 So in the first year, the first $,000 annual interest rate is 6% You will get $60, which is 6 times what you can get with a bank before What is the risk It is not 0 anymore, it does not have FDIC insurance The Federal Reserve System will not say that they will Give you money when the bank fails Even if they don’t have them, they will go to print This is the risk that the company will not repay the money So the company doesn't pay back So this company may go bankrupt If it goes bankrupt, all its creditors will go Chasing its property Maybe you are squeezed behind Maybe this company doesn’t have enough assets to pay back the owner’s money So there are some risks, the home company may fall You never know what will happen But because this is a very reputable company And if we say, it has a lot of assets It has a very stable business, Whether the economy is good or not, it performs well, and the probability of bankruptcy is very low So I write "low risk" here Because we assume that he has a good reputation There are a lot of things like property Now, suppose even 6% You still hope to get more You can do better.

Suppose you have a friend He said he just started as a doctor So he has a very stable job He just started as a doctor stable income He can earn $200,000 per year But he just came out of medical school Want to buy a house So he started looking for someone Who can help him pay the down payment for the house? So your reward… He said who would lend me I will pay him 8% annual interest Annual interest…, looks great Stable income, only $1,000, He didn’t want to buy a very expensive house, he wanted to buy one for $200,000 He wants to pay a down payment of $40,000 Seems to be in line with his income But there will always be some risks, there will always be some The risk of him not paying Who knows? hope this won't happen Maybe something happened to him Maybe he can't be a doctor Maybe his health is in trouble Maybe his personality is easy to become addicted to something He likes to drink all his money Or he likes to gamble them all And that's why he needs to borrow money So there are some risks, there is a risk that he will not pay But all the signs show that he is safe But he is undoubtedly more risky than this company Because when he doesn’t pay, he has no assets to offset It’s impossible for the company to be hit by a bus one day people can So, the company basically No way to become a drunkard, but a person can Who knows? we don't know But at least this doctor’s risk is indeed higher He doesn't have the assets you can chase after But maybe this kind of remuneration is still unconstructed You say you know there is a way to make more "I can earn more in the stock market" So you look at your other option, suppose you want to invest…

Invest in the stock market Invest in the stock market, you plan to invest in a bunch A very broad investment portfolio, which can be regarded as investing in the entire stock market The reward is the profit of the entire stock market So you look at the past record of the stock market, and you say "Look… Although it goes up and down every year, but in the long run People seem to… This is not real data… but people seem to Earn an average of 10% per year So it looks good, but what about the risks? The risk is that this prediction is only based on historical records Profits in the market in the past There was a time in the market I’m talking about ten years, twenty years, thirty years The stock market is flat, even the stock market is falling The market may fall by double digits every year For example, 30%, 40%, or even bad times You are really not sure Can you get 10% of your annual So I said the risk is volatile Volatility means it goes up and down Jump up and down It will not be straight up Like the previous deposit account Fluctuating, and you have a big chance…

Will lose the money you invested It may fall every year, even every month Or any 5 years, or any 10 years So, he seems to be a very risky thing You might lose everything So assuming that even 10% can’t satisfy you You said, I want to see if I can get it More paid So you have a brother-in-law who is unemployed for a while Let me write "Uncle" here Your uncle is unemployed For a short time, he said it wanted to start him A plan to make money For $1,000 to buy equipment Let him start a business in his garage, if paid… We have many ways to determine remuneration We can ask him to borrow money from you If we can let you into his stock So suppose the reward is 50% of the shares 50% of his business Then suppose your brother-in-law is right This has become a million-dollar business So it’s very, very, very high pay If your brother-in-law is right What is the risk? The risk is obviously he was wrong He spent all your money You lost everything And what you lose may not just be the money you invested in You lost your relationship The relationship between you and your uncle, and even your wife So the risk of the relationship, I should put your family at risk Family and happiness Once your uncle lost all your money Thanksgiving may not be so good It's hard to gossip about home So overall, maybe I said too many situations You should see this trend Generally speaking, the more risk you bear You can expect more rewards In other words, the more you expect to get paid It is very likely to bear more risks If something looks safe But it’s high pay, and one of those two items is probably not true.

If we want to draw these as a table I haven't really quantified these. I haven't taught you how to measure risk In the following videos, we can think about this together Scholars thought of several ways to measure risk So this is risk and reward. If I draw him here as a chart Deposit account is zero risk, deposit account is here Your compensation is 1%, so this is 1% Lend to a reputable company The risk is a little bit bigger, here The risk is higher than before, your reward is 6% So…, 6% is here The risk is a little higher It means that the risk is rising If I loan it to the doctor, let me choose a color that I haven’t used yet If you lend it to a doctor, again, the risk is higher Higher than loaned to company or deposited into account Again, the reward is higher, the reward is higher You now have an 8% return and invest in the stock market Let me choose a color I haven't used yet Invest in the stock market…

again Higher risk, higher reward Maybe 10% per year, 10% here Your brother-in-law, super high risk Maybe it broke But it’s also very rewarding, maybe like such The basic concept is that the higher the risk, the higher the reward.

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