Risk and Return | Corporate Finance | Part 2 | Section B | Episode 09 | CMA USA

Welcome to CMA USA exam coach, your study companion. Today, we are beginning a new chapter from part two, section B of the CMA syllabus, corporate finance. In this episode, we are diving into one of the foundational concepts in finance, that is risk and return. This is a crucial topic that helps us understand how uncertainty impacts investment decisions and how returns are measured and evaluated. So, let's get started and build a strong foundation for mastering the rest of corporate finance. Before we start discussing risk, let's first understand what the share market is. The share market, also known as the stock market, is a platform where investors buy and sell ownership in companies represented as shares or stocks. When you buy a share, you're essentially buying a small piece of that company. The value of your investment can rise or fall based on the company's performance and overall market conditions. The share market plays a key role in connecting investors with companies seeking capital, and it's where the concept of risk and return becomes most visible in real time. With that foundation in place, to understand stock market better, let's take a simple story. Meet John, the ambitious founder of ABC Corporation, a startup he began in a small rented office. At the start, all John had was a big dream, a solid product idea, and a laptop. But what he lacked was money. He wanted to launch his product in the local market, but he needed capital. So what did he do? Stage one, the first supporter's friends and family. John called his close friends and family together and said, I believe in this business, but I need your support. If you invest in me, I promise to share a part of the profits with you. His uncle gave Dollar 500,000. His best friend pitched in USD 200,000. His sister loaned him USD 100,000. They didn't ask for interest. They believed in his dream. In return, John gave them a profit-sharing agreement, a small ownership in his company. And with that, ABC Corp was born. Stage two, growth in the bank loan. Business grew, clients came in, revenue multiplied. But soon, John faced a new challenge, expansion. He needed bigger factories, more staff, and new technology. This time, he approached a bank. The bank approved a business loan of $5 million. John used it to scale operations across the region. But with loans came EMIs and interest, and that meant a growing financial burden. Still, ABC Corp pushed forward, expanding to multiple cities. Stage three, the big leap going public. Now, six years later, ABC Corp is a recognized brand. John's products are sold in every major city. But now, he dreams of taking his business international, exporting, building factories overseas, investing in research and development. This kind of growth requires huge capital, much more than what friends, family, or banks can offer. So this time, John decides to go public. Let's raise funds from the public and make them part of our journey. And that's where the story of the share market, or stock market, begins. What is a share market? The share market, also known as the stock market, is a public marketplace where companies raise money by selling shares of their ownership to investors. When a person buys a share, they are essentially buying a piece of the company, becoming a partial owner. These investors are called shareholders. The main goal for companies is to raise capital for expansion, operations, or new projects. For investors, it's an opportunity to grow their wealth. Shareholders earn returns in two primary ways. Dividends, which are a portion of the company's profits, paid out to shareholders, and capital gains, which occur when the value of their shares increases over time, and they sell at a higher price than they paid. The share market is dynamic. Prices go up and down based on company performance, economic factors, news, and investor sentiment. That's where the concept of risk and return begins to come into play. How does a company get listed on the share market? For a company like ABC Corporation to sell its shares to the public, it must first get listed on a stock exchange, such as the New York Stock Exchange, or NASDAQ. This process is known as an initial public offering, or IPO. In an IPO, the company works with investment banks to determine how many shares to offer and at what price. It must also meet regulatory requirements, submit financial disclosures, and comply with stock exchange rules. Once approved and listed, the company's shares begin trading in the open market. From that point on, anyone, institutional investors, or the general public, can buy and sell the company's shares on the exchange. This transition from private to public brings more capital, but also more scrutiny and accountability. Let's understand what is investment banking. Investment banking is a specialized segment of banking focused on raising capital for companies, governments, and institutions. Investment banks do not accept deposits or offer loans like commercial banks. Instead, they act as intermediaries between companies and investors. Major investment banks include Goldman Sachs, Morgan Stanley, JPMorgan Chase, Investment Banking Division, Bank of America, Merrill Lynch. Who are investment bankers? They are professionals working in investment banks. They specialize in underwriting new securities, advising on mergers and acquisitions, asset management for institutions, market making, and research. Let's look at the roles of investment banks in the IPO process. First comes due diligence and valuation. Here, investment banks examine the company's financial records, legal standing, and operations. They analyze market conditions and competition to help determine the fair value of the company and set an IPO price range. Next is underwriting. Investment banks commit to purchasing the company's shares and selling them to the public. This removes the risk from the company and places it on the bank. There are two types, firm commitment, where the bank guarantees to buy all shares, and best effort, where they try to sell without a guarantee. Then comes marketing the IPO, also known as the roadshow. Executives and bankers meet with large investors to pitch the company, answer questions, and build excitement. This helps engaging demand and setting the final price. Fourth is regulatory filings. The bank assists with preparing legal documents like the S-1 registration, ensuring compliance with authorities like the SEC in the U.S. Fifth, they handle pricing and allocation. Once investor interest is clear, they finalize the IPO price and decide how many shares go to institutional investors, individual investors, and company insiders. Finally, investment banks offer aftermarket support. After the IPO, they may buy shares on the open market to stabilize prices and publish research to help with future trading. Once again, let's understand some of the term in stock market. First, we have the IPO, or initial public offering. This is when a company offers its shares to the public for the very first time. It's how a private company becomes publicly traded on a stock exchange. Next, we have the FPO, or follow-on public offering. After completing an IPO, if the company needs to raise more funds, it can issue additional shares to the public. This is called a follow-on offering. Now, how do people actually buy and sell shares? The buying and selling of shares happen through stock exchanges, like the New York Stock Exchange, or NASDAQ. Investors use brokers or online trading platforms to make these transactions. What makes share prices go up or down? The price of a share is mainly determined by demand and supply, but it's also influenced by the company's performance, future growth prospects, investor sentiment, economic trends, and even political news. So, who participates in the stock market? The market includes a wide range of participants, individual investors, large institutions like mutual funds and pension funds, and even traders who buy and sell frequently for short-term gains. Let's now talk about two common terms, bull market and bear market. A bull market refers to a period where stock prices are rising and optimism is high. On the other hand, a bear market is when prices are falling and investors become more cautious. Next, we have the stock market index. An index, such as the S&P 500 or Dow Jones, is a group of selected stocks that represent the overall health of the market or a specific sector. Investors often look at indices to gauge market performance. Why do people invest in stocks? The main goal is to grow their wealth. Investors can earn returns in two ways, through dividends and through capital gains when the share price increases over time. But we should also understand the risks involved. Investing in stocks comes with uncertainties. The value of shares can fluctuate due to various factors, including poor company performance, economic slowdown or unexpected global events. So it's always wise to research carefully and diversify your investments. These are some key terms every investor should know before stepping into the world of corporate finance and capital markets. Stay tuned as we continue to break down these concepts in a simple and effective manner. Today, ABC Corporation is not just John's dream. It's owned by thousands of shareholders who believed in his journey. Every time the company grows, shareholders benefit. That's the power of the share market. It connects businesses and the public, creating value for all. That brings us to the end of this introductory session. All the information we covered so far, like IPOs, share markets, bull and bear trends, and stock market participants, is foundational knowledge about how the stock market works. The important topic we were discussed is the role of investment banks in the IPO process. This is a specific topic that is important in CMA syllabus, and you are expected to understand it clearly for your exam. As CMA students, it's important to have a broad understanding of financial markets, and that's exactly what we've built here today. We are now coming back to our CMA exam topic, risk and return. So what exactly is risk? Risk, in financial terms, refers to the possibility that the actual return on an investment will be different from the expected return. In simple words, it's the chance that things won't go as planned. Uncertainty refers to a situation where future outcomes are unknown and probabilities cannot be assigned. It is the lack of complete certainty about the future, and it's not measurable in a statistical sense. This brings us to the concept of uncertainty. While both risk and uncertainty involve unknown outcomes, there's a key difference. Risk is when we can assign probabilities to the outcomes. We know what could happen and how likely it is. Uncertainty is when we don't have enough information to assign probabilities. The outcomes are completely unknown or unpredictable. Key insight. All risks involve uncertainty, but not all uncertainties involve risk. Risk is a subset of uncertainty where enough information is available to quantify the outcomes. In decision-making, risk can be modeled, but uncertainty requires strategic flexibility and contingency planning. To understand risk and uncertainty more clearly, let's take a simple example. Imagine George receives a mysterious box. It looks valuable, like a treasure chest. Now, what's inside the box is completely unknown. It could be gold coins, or it could be something dangerous, like a snake. At this moment, George is facing uncertainty. He has no clue what's inside and no way to assign a probability to what the outcome might be. Now, suppose someone tells George, there's a 70% chance the box contains treasure and a 30% chance it's something harmful. Now we've moved from uncertainty to risk. Risk exists when you know the possible outcomes and can assign a probability to each. So to summarize, uncertainty is when George doesn't know anything, no idea what could happen. Risk is when he knows the possibilities and how likely each one is. This is exactly how risk and uncertainty work in finance, too. When we invest in stocks, we face risk because we have historical data and probabilities to help us estimate returns. But when we enter into unknown territory with no information, that's uncertainty. Types of risk. There are mainly two type of risks to be discussed. First one is pure risk and the next, speculative risk. Pure risk refers to situations where only the possibility of loss or no change exists and there is no opportunity for gain. It's also known as insurable risk because unlike speculative risk, it cannot be managed directly. Instead, pure risk can only be mitigated through insurance or transferring the risk to an insurance company. An example of pure risk includes natural disasters like floods, earthquakes, or hurricanes. Accidents such as car crashes or workplace injuries as well as health-related issues like illnesses or diseases are also examples of pure risks. Since pure risks cannot be managed or avoided directly, the primary way to handle them is through insurance. For example, someone might buy health insurance to cover the financial risks associated with medical expenses due to illness or an accident. Speculative risk refers to situations where both the potential for gain and loss exist. Unlike pure risk, speculative risk involves decisions that could result in either a positive or negative financial outcome. It's often linked with investments or business ventures. Examples of speculative risk include stock market investments where the value of investments may either increase, leading to a profit, or decrease, leading to a loss. Starting a new business is another example where the business could either succeed, resulting in profit, or fail, leading to a loss. Speculative risk can be managed through decisions. For instance, you can choose to avoid or postpone investments when market conditions are unfavorable. Diversification and hedging strategies are also commonly used to reduce the impact of speculative risks. For example, an investor might choose to diversify their stock portfolio to spread out the risk or postpone an investment decision until market conditions improve. Let's focus on speculative risks, the kind of risks corporations deal with in everyday investment decisions. These are not like pure risks which only result in loss. Speculative risks can lead to either profit or loss. Let's break down the major types relevant to your CMA syllabus. First up, liquidity risk. This is the risk of not being able to quickly convert your asset into cash without losing value. Imagine your company owns a large office building. You suddenly need cash to pay off some urgent liabilities, but the real estate market is slow. You're stuck. That's liquidity risk. Next, credit default risk. Suppose your business lent money to a supplier or bought corporate bonds. If they fail to pay back, you suffer a financial hit. That's the essence of credit risk, failure to fulfill payment obligations. Then comes purchasing power risk, also called inflation risk. Even if your business earns a 5% return, but inflation is 6%, you've technically lost 1% in real value. It means your money's power to buy goods has dropped. Foreign exchange risk is another one. Let's say your US-based company exports to Europe and gets paid in euros. If the euro loses value compared to the dollar, your income drops, even if your sales were strong. Next, political risk. This happens when government policies or instability affect your business. For example, a foreign government might suddenly restrict trade or change tax rules, harming your operations or profitability. Now let's talk about business risk. This comes from your own company's internal operations. A failed product launch, poor strategy, or bad management decisions all can cause business loss. Closely related is industry risk, that is, risk tied to your sector. For instance, if you're in the textile industry and new global laws impose heavy tariffs on garments, every company in your industry will be affected, no matter how efficient they are. And finally, market risk, also called systematic risk. This affects the entire market, like a financial crisis or global recession. Even the most profitable companies can see their stock values fall when the whole market is going down. Here's something important. Systematic risk is not controllable because it affects the entire economy or market. You can't control a recession or an interest rate hike. But unsystematic risk is controllable. It's limited to a specific company or industry. As a business, you can reduce this risk by diversifying or even changing industries. That's why it's considered manageable. Understanding these risks will help you analyze investments better and make smart, informed decisions, exactly what CMA professionals are trained for. Now that we've understood different types of risk, let's move on to two important concepts, First, what is risk aversion? Risk aversion means the tendency to avoid uncertainty and risk. A risk-averse person or company prefers safe and predictable outcomes, even if that means accepting lower returns. They prioritize stability and the protection of capital over the chance to earn big profits. Let's take an example. John has $10,000 to invest. He has two options, a government bond that gives a 4% return or a startup stock that might return 15%, but also has a high chance of losing value. John chooses the government bond because it is safer. That means John is risk-averse. In the same way, a risk-averse business might avoid launching a new product or entering a new market unless it is very sure about the success. The goal is to avoid loss, even if it means missing an opportunity. Now let's understand risk appetite. Risk appetite is the level of risk that a person or business is willing to accept in order to achieve a goal. Someone with high risk appetite is open to taking bold decisions that come with higher potential returns, even if they carry a possibility of failure. For example, ABC Corporation is planning to expand into the cryptocurrency space. They understand it's risky, but they believe the growth opportunity is worth it. They're willing to take the risk. That shows they have a high risk appetite. Every company has a different level of risk appetite, and it may also change over time. Startups usually have higher risk appetite in early stages, while established companies may become more cautious and risk-averse. So, to summarize, risk aversion is about avoiding loss and staying safe. Risk appetite is about being ready to take calculated risks for bigger rewards. Both of these influence decisions in investing, budgeting, and corporate strategy. Now let's talk about a key concept in finance, risk and return. In simple terms, risk and return are directly related. This means the higher the risk you take, the higher the potential return. The lower the risk, the lower the expected return. This is one of the most important principles in investing and corporate finance. Let's understand this with an example. Imagine you have some money to invest. You have two choices. First, one savings account in a bank that offers 3% interest per year. Second is a company stock that might give 15% return, but also has a chance of losing value. If you choose the savings account, you're taking very little risk, and therefore getting a small return. If you choose the company stock, you're accepting more risk, but you may earn more return. This trade-off is what we mean by the risk-return relationship. Here's how it applies in the corporate world. A company planning a new project must evaluate. How risky is the project? Is the expected return high enough to justify taking that risk? This is where risk management comes into play. Companies aim to balance risk and return to maximize shareholder value. They will only take more risk if they expect a higher return in the future. For example, a company may invest in a new overseas market. It involves foreign exchange risk and political risk, but if the potential profits are high, it may be worth it. So, to summarize, more risk means more potential return, but also more chance of loss. Less risk means safer investments, but smaller profits. Successful financial decisions require finding the right balance between risk and return. Now let's explore one of the most important concepts in finance, the capital asset pricing model, also known as CAPM. KPM is used to calculate the expected return on an investment, based on how risky it is compared to the overall market. The logic behind CAPM is simple. Investors expect to be rewarded in two ways. One, for the time value of money, and two, for taking on risk. The formula for CAPM is expected return equals the risk-free rate plus beta multiplied by the market risk premium. In equation form, it looks like this. Expected return equals risk-free rate plus beta multiplied by market return minus risk-free rate. Now let's understand each term. The risk-free rate is the return from an investment with zero risk, usually a government bond. Beta is a measure of how much the investment moves compared to the market. If beta is one, it moves exactly like the market. If it's more than one, it's more volatile. Less than one, it's less volatile. Market return is the average return expected from the whole stock market. And the market risk premium is the extra return the market gives over the risk-free rate to compensate for the risk. So in simple terms, CAPM helps us figure out how much return an investor should demand for a particular investment, given its risk level. It's a key concept used in valuing stocks, assessing projects, and estimating cost of equity. So what is the risk-free rate? It is the theoretical return an investor would expect from an absolutely risk-free investment, meaning there's no chance of default, and the investor is guaranteed to get back both the principal and the interest. But in the real world, there's no such thing as a perfectly risk-free investment. So financial professionals commonly use the U.S. Treasury bill, or T-bill, as the closest alternative to a risk-free investment. Why the U.S. Treasury bill? Because it is backed by the full faith and credit of the U.S. government, which makes default practically impossible. T-bills are short-term debt instruments, often with maturities of three months, six months, or one year, and they do not pay interest directly. Instead, they are issued at a discount and mature at face value. The difference is the investor's return. Let's understand the risk-free rate using a real-world example with the U.S. Treasury bill, also known as a T-bill. When you invest in a T-bill, you're not buying it at its full value. Instead, you purchase it at a discount. For example, suppose the face value This is the amount you will receive at maturity, in this case, six months from now. But today, you don't pay $1,000. You buy it for $980 at a discounted price. You don't receive any interest payments during the six months. But when the T-bill matures, you receive the full $1,000. That means you paid $980 now, and after six months, you get $1,000 back. The $20 difference is your gain, and it's guaranteed by the U.S. government. This return is considered risk-free because there is almost no chance of default by the U.S. government. That's why in finance, especially in models like CAPM, this type of return is used as the risk-free rate. It's the base level of return for an investment with no risk at all. So to recap, you pay $980 today. You get $1,000 in six months. The $20 is your safe and guaranteed gain, called the risk-free rate. Next, we will discuss beta, a key component in the CAPM equation. So what is beta? Beta measures how much a stock or investment moves in relation to the overall market. It reflects the investment's volatility or systematic risk, the kind of risk that you cannot eliminate because it affects the whole market. Beta of the market itself is always one. Now let's understand what it means if an investment's beta is more than one, less than one, or equal to one. If beta equals one, the investment moves in line with the market. If the market goes up by 10%, your investment also goes up by 10%. It has average market risk. If beta is greater than one, the investment is more volatile than the market. For example, a beta of 1.5 means that if the market increases by 10%, your investment may go up by 15%. This stock is considered high-risk and high-return. It's attractive to risk-seeking investors who are looking for aggressive growth. If beta is less than one but greater than zero, the investment is less volatile than the market. For example, a beta of 0.6 means that if the market rises by 10%, your investment might go up by only 6%. This is called a defensive stock. It's stable and less sensitive to market movements. Such investments are preferred by risk-averse investors or conservative portfolios. If beta is negative, which is rare, it means the investment moves in the opposite direction of the market. For example, gold sometimes has a negative beta. When markets crash, gold prices might go up. So, beta tells us how risky a stock is compared to the market, and helps investors decide whether the investment matches their risk appetite. Now, let's understand what we mean by market return in the CAPM equation. Market return is the average return expected from the entire stock market. It represents how much return investors expect to earn from a broad and diversified market portfolio. A common benchmark used to estimate market return is the performance of stock indices like the S&P 500 in the United States. For example, if the S&P 500 has historically delivered an annual return of around 10%, we consider that as the market return. This value is important in the CAPM formula because we use it to calculate the extra return an investor expects to earn by taking more risk compared to a risk-free investment. This extra return is known as the market risk premium. Market risk premium is the additional return an investor expects to earn by investing in the stock market instead of a risk-free investment. In simple words, it is the reward for taking on extra risk. To calculate the market risk premium, we subtract the risk-free rate from the market return. For example, if the expected market return is 10% and the risk-free rate is 3%, then the market risk premium is 7%. This premium reflects how much more return an investor needs for investing in a risky market compared to a safe investment like a U.S. Treasury bill. The higher the risk in the market, the higher the market risk premium investors will demand. Let's now do a simple practical example using the Capital Asset Pricing Model, or CAPM. Imagine an investor wants to know the expected return from investing in a company's stock. The risk-free rate is 3%. The market return is 10%. The beta of the stock is 1.2. Now let's apply the CAPM formula. Expected return equals the risk-free rate plus beta times the market return minus the risk-free rate. Substitute the values into the formula. Expected return equals 3% plus 1.2 times 10% minus 3%. Expected return equals 3% plus 1.2 times 7%. Expected return equals 3% plus 8.4%. Expected return equals 11.4%. This means the investor can expect to earn 11.4% return on this stock, considering its risk compared to the overall market. To conclude, if the investor chooses a risk-free investment like a treasury bill, the return would be only 3%. If they invest in the overall market, the average return would be around 7%. But by investing in this particular stock with a beta of 1.2, they can expect a higher return of 11.4% because they are taking on higher risk. We are going to discuss the Security Market Line, also known as the SML. The Security Market Line is a graphical representation of the Capital Asset Pricing Model, or CAPM. It shows the relationship between the expected return of an investment and its systematic risk, which is measured by beta. On the SML graph, the horizontal axis represents beta, that is, the level of risk. The vertical axis represents the expected return. The risk-free rate is the point where the line starts on the vertical axis, because a beta of zero means no risk, and the expected return in that case is the risk-free rate. The slope of the SML represents the market risk premium. This is the difference between the expected return on the market and the risk-free rate. Every security or stock should lie on the Security Market Line if it is fairly priced. If a stock lies above the line, it means the stock is offering a higher return for its level of risk. That means it is undervalued and considered a good buy. If a stock lies below the line, it means the return is too low for the level of risk. That means it is overvalued and not attractive. This is how CAPM helps in pricing assets. By using the CAPM formula, we calculate the expected return for a given beta. Then we plot this return on the Security Market Line. Let's connect this back to our earlier example. We calculated an expected return of 11.4% for a stock with a beta of 1.2. On the SML, we plot beta as 1.2 on the horizontal axis and 11.4% on the vertical axis. If the actual return of this stock is higher than 11.4%, then it will appear above the line, indicating a good investment. If the actual return is lower than 11.4%, it will appear below the line, indicating a poor investment. So the Security Market Line helps us visually assess whether a stock is properly valued based on its risk and expected return. Now let's understand two important concepts in stock analysis, overvalued and undervalued stocks. What does it mean when a stock is overvalued or undervalued? An overvalued stock means the current market price is higher than its actual or intrinsic value. On the other hand, an undervalued stock means the current market price is lower than its intrinsic value. So basically, the market is either paying more or less than what the company is truly worth. How does this happen? Market prices are driven by demand and supply. Investor sentiment, future expectations, news and trends can push a stock price up or down, sometimes beyond what is justified by the company's fundamentals. When there's too much optimism, investors may keep buying a stock, inflating the price and making it overvalued. When there's pessimism or fear, investors may sell a stock, even if the company is strong, leading to undervaluation. What happens to overvalued and undervalued stocks? In the long run, prices tend to move toward their true value. This is called market correction. An overvalued stock may experience a price drop once the market realizes it's too expensive. An undervalued stock might see a rise in price once the market recognizes its true potential. Reasons for overvaluation. Speculation or hype around the company. Strong recent performance driving investor excitement. Low interest rates making stocks more attractive. Media attention and positive news coverage. Misleading financial reporting or window dressing. Reasons for undervaluation. Poor recent performance or negative news. Market overreaction to short-term problems. Lack of investor awareness or coverage. Economic downturns affecting all stocks. Strong fundamentals not yet recognized by the market. Conclusion. As a smart investor or financial analyst, your goal is to identify undervalued stocks before the market corrects them because they offer the potential for gains. At the same time, be cautious of overvalued stocks as they may fall when reality sets in. Understanding valuation helps you make better investment decisions. Let's now look at the risk and return relationship for different types of financial instruments. These are arranged from least risky to most risky following the basic principle. More risk means more potential return. We will explain each one in a simple way. U.S. Treasury bills. These are short-term government securities. They're considered risk-free as they are backed by the full faith and credit of the U.S. government. Returns are low, but your investment is very secure. First mortgage bond. This is a debt secured by real estate or property. If the company fails to pay, the bondholders have first claim on the asset. Because of this security, risk is low and returns are slightly higher than Treasury bills. Second mortgage bond. Also backed by real estate, but the claim is secondary to first mortgage holders. This means slightly higher risk and return compared to the first mortgage bond. Subordinated bond. This is an unsecured debt that is repaid only after senior debts are satisfied. This makes it riskier, but it offers a better return than secured bonds. Income bond. Interest is paid only if the company earns sufficient profits. There's no guarantee of return, which increases the risk. However, the return potential is also higher to compensate for that. Preferred shares. Preferred shareholders receive fixed dividends before common shareholders. These shares offer moderate risk, higher than bonds, lower than common stock, and steady returns. Convertible preferred shares. These are preferred shares that can later be converted into common stock. They offer regular income and also the potential for capital appreciation, making them a bit riskier, but more rewarding, than regular preferred shares. Common shares. These represent ownership in a company. They are last in line during liquidation, but offer dividends and capital gains. They carry high risk and high potential return, depending on how the company and the market perform. Options. Options are contracts that give the right, but not the obligation, to buy or sell a stock at a specific price. They are highly speculative and can expire worthless, making them very risky. However, if the market moves in your favor, they can deliver very high returns. Futures. Futures are contracts that obligate the buyer to purchase or sell an asset at a future date and price. They're widely used in commodities and currency markets. Because of the leverage involved, even a small price movement can cause large gains or losses. This makes them one of the riskiest financial instruments, with the potential for both large profits and large losses. In conclusion, the greater the risk, the greater the expected return. Understanding this risk-return ladder helps you make smart investment decisions based on your goals and risk tolerance. Let's quickly summarize what we learned in this episode of Risk and Return. We cover the following key topics. What is a share market? The roles of investment banks in the IPO process. IPO, initial public offering. Understanding risk and uncertainty. The link between risk and return. Pure risk and speculative risk. Systematic and unsystematic risk. Risk aversion and risk appetite. The capital asset pricing model, KPM. Security market line, SML. The relationship between risk and return. We recommend you now try solving some CMA practice questions on these topics to strengthen your understanding. Thank you so much for watching. This is your CMA USA exam coach, and we'll see you in the next episode.