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Risk Neutral

Risk neutral is an investment term which represents a mindset in which investors make decisions based on expected returns and expected gains, unencumbered by the expected risks. It is a useful concept that allows investors to eliminate the 'risk factor' from the equation when weighing up their decisions.

Risk-neutral investors don't take into consideration the riskiness of any investment when making decisions. It can be a useful tool because it can help to remove the fear of losing money that often comes with making a risky investment. Rather than being preoccupied with the chances of failure, a risk-neutral investor is focused purely on the potential profits. The concept of risk neutrality can be actively adopted by investors and is a valuable tool in ensuring rational decision making.

Risk neutrality plays an important role in derivatives pricing, as it helps investors to accurately identify and quantify expected returns. There are two key concepts that are important to understanding how derivatives pricing works. The first is the risk-free rate, which is the rate of return of a hypothetical risk-free period. The second is the expected returns of the derivative instrument, taking into account implicit costs and risks. By looking at both of these factors, investors can accurately price derivatives.

Risk neutrality is a useful approach for investors to adopt as it can help them to make more rational and profitable decisions. By eliminating the fear of the unknown, risk-neutral investors can focus on the expected returns of an investment. This helps them to accurately price derivatives and make decisions which are more likely to be profitable in the long run.

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