Entrepreneurship and Small Business (ESB) Certification Practice Exam

What is the term for the amount of loss one is willing to take when making an investment decision?

1. Investment portfolio

2. Market risk

3. Risk tolerance

4. Return on investment

The correct answer is: Risk tolerance

The term that refers to the amount of loss one is willing to accept when making an investment decision is known as risk tolerance. Risk tolerance is a critical concept in investing as it helps individuals assess their comfort level with potential losses versus the possibility of gains. This capacity varies from person to person, influenced by factors such as financial situations, investment goals, and psychological readiness to handle volatility in the market. Understanding one's risk tolerance is essential for creating an investment strategy that aligns with individual objectives and capabilities. Investors with a high-risk tolerance may choose to invest in more volatile assets that offer potentially higher returns, while those with a lower risk tolerance might prefer more stable investments with lower returns to minimize the chance of a loss. The other options do not accurately capture this definition. An investment portfolio refers to the collection of financial assets held by an investor, market risk describes the potential for an entire market or sector to decline, and return on investment measures the profitability of an investment rather than one's willingness to incur losses. Therefore, risk tolerance is the most precise term in this context.