Financial Economics: Risk and Return.

Copyright GH

January 8, 2024

Financial economics is known as the branch of economics that focuses on studying how economic agents make financial decisions and manage scarce resources in the financial realm. The two fundamental concepts in this field are risk and return, which play a significant role in investment and financing decisions. Here’s the key information defining these concepts:


Financial risk refers to the possibility that the actual returns on an investment may differ from the estimated returns.

Sources of Risk:

Market Risk: Related to fluctuations in financial markets.

Credit Risk: Relative to the possibility of a borrower defaulting on obligations.

Operational Risk: Derived from internal issues within an organization.

Systemic Risk: Inherent to the entire financial system.

Risk Assessment:

Investors assess risk through technical analysis, fundamental analysis, and risk valuation models.


Financial return is the profit or yield obtained from an investment in relation to the amount invested.

Factors Influencing Return:

Expected Return: Based on market analysis, economic conditions, and specific company factors.

Cost of Capital: The cost of obtaining financing influences the required return.

Effective risk management and the pursuit of sustainable returns are of utmost importance in financial decision-making. Investors and financial institutions must balance these two elements to achieve their financial objectives and maximize the value of their investments.