Which concept relates to an investor requiring higher expected returns as risk increases?

• A. Risk tolerance
• B. Risk averse
• C. Risk neutrality
• D. Risk seeking

Answer: (B)

The concept that directly relates to an investor requiring higher expected returns as risk increases is risk aversion. Risk-averse investors prefer lower levels of risk and usually demand higher expected returns as compensation for taking on additional risk. This fundamental principle reflects the idea that as uncertainty or potential for loss increases, investors seek greater rewards to justify the risk they are undertaking.

In finance, risk-averse behavior is characterized by a decreasing marginal utility of wealth. This means that as an investor's wealth increases, the additional satisfaction or utility derived from each additional unit of wealth decreases, leading them to be more cautious when it comes to investing. Investors with a risk-averse profile would choose a portfolio with lower risk even if it offers lower returns, preferring stability and capital preservation over potentially higher but uncertain future gains.

Other concepts, such as risk neutrality and risk seeking, represent different attitudes towards risk. Risk neutrality implies that an investor values potential return and risk equally, while risk-seeking investors are willing to take on more risk without necessarily requiring higher returns. However, since the question specifically addresses the relationship between increased risk and the expectation of higher returns, the notion of being risk-averse is the most appropriate answer.