It is also important to note that the relative degree of risk against the return does not need to be in linear relation i.e. it is not necessary that the risk and return increase in same proportion however, if risk increases, it is necessary that the return must increase too in order to compensate the investors for taking increased risk. (Ante, 2009). The above graph therefore indicates that the investment four has the highest risk and highest return whereas investment 1 has the lowest risk and lowest return. This graph also indicate that the investors may be preferring different combinations of the investments i.e. the investment that is providing lowest returns may be made in the government treasury securities whereas investment providing highest returns may made in the stocks of a corporate as the stocks provide highest returns and also carry greatest risk among all instruments of investment.
It is important to understand that the expected return is always calculated by multiplying the return with the probability and the resulting figure is called the expected return on any investment. Therefore the investment that provides highest expected return shall be chosen over other investment. The investor should choose an investment that pays a guaranteed return of 7% because given the overall probability of different returns, the investors will get the expected return of 5% with a probability of 0.5 whereas the investment providing 7% result has the probability of 1 that means the expected return will be 7% which is highest as compared to other investment. The higher the probability greater are the chances that the return will be guaranteed therefore an investment with a lower probability will yield lower expected returns whereas an investment with higher probability of getting the same return will yield higher expected returns. Therefore in this case, since the probability of getting 7% return is