Which of the following statements about investments and risk is true?

• A. Higher potential returns on investments are generally associated with higher levels of risk.
• B. Investments in government bonds always carry more risk than stocks.
• C. Risk can be completely eliminated by diversifying a portfolio.
• D. All investments guarantee a fixed return regardless of risk.

Answer: (A)

Verified step by step guidance

1. Understand the concept of risk and return: In financial accounting and investing, risk refers to the uncertainty of achieving expected returns. Higher potential returns are typically associated with higher levels of risk because investors demand greater compensation for taking on more uncertainty.
2. Evaluate the statement 'Higher potential returns on investments are generally associated with higher levels of risk': This is a fundamental principle in finance known as the risk-return tradeoff. It is generally true that investments with higher expected returns, such as stocks, carry higher risk compared to safer investments like government bonds.
3. Analyze the statement 'Investments in government bonds always carry more risk than stocks': Government bonds are typically considered low-risk investments because they are backed by the government. Stocks, on the other hand, are subject to market fluctuations and are generally riskier than government bonds. This statement is false.
4. Examine the statement 'Risk can be completely eliminated by diversifying a portfolio': Diversification reduces risk by spreading investments across different assets, but it cannot completely eliminate risk. Systematic risk, which affects the entire market, cannot be diversified away. This statement is false.
5. Review the statement 'All investments guarantee a fixed return regardless of risk': Investments do not guarantee fixed returns, as returns depend on the type of investment and associated risks. For example, stocks and mutual funds have variable returns based on market performance. This statement is false.