Expected Rate of Return, Risk, and Actual Rate of Return

The expected rate of return refers to how much a project or an investment is expected to return to the

investor, either in future interest payments, capital gains, or increased profitability. It is usually the average

return over a period of time, usually in years or even decades. We normally measure it as a percentage rate.

Risk measures the uncertainty of that project’s profitability. There are several types of risk, including default

risk and interest rate risk. Default risk, as its name suggests, is the risk that the borrower fails to pay back the

bond or loan. Interest rate risk is the danger that you might buy a long term bond at a 6% interest rate right

before market rates suddenly rise, so had you waited, you could have received a similar bond that paid 9%. A

high-risk investment is one for which a wide range of potential payoffs is reasonably probable. A low-risk
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