The main objective of this chapter is for students to demonstrate that they can identify the manner in which managers, investors, and analysts perceive the relationship between risk and return.

After completing this chapter students will be able to:

1. Identify managers’ perceptions about the characteristics that underlie risk andreturn.
2. Explain why heuristics based on affect and representativeness lead managers and investors to associate higher expected returns with lower risk.
3. Analyze how representativeness leads managers, investors, and market strategists to form biased judgments about the market risk premium.
4. Describe conditions under which the heuristic “one discount rate fits all” destroys value.