Risk-neutral measures are financial metrics used to adjust for risk, allowing for a more accurate comparison between investments. They are used to reflect the difference in risk between two investments and help investors determine which one offers a better return on investment. Risk-neutral measures can include options and swaps, which are contracts that allow investors to shift risk away from themselves while still potentially earning a positive return. Risk-neutral measures are valuable because they inform investors of the additional return they could expect to earn by taking on additional risk, or the amount of compensation they would need to accept in order to take on a lower-risk investment.

Risk-neutral measures are based on the important concept of expected value, which is the average return of an investment over time. Expected value takes into account both the total amount of future gains and losses, as well as the probability of each. Risk-neutral measures can be used to calculate the higher expected return of an investment that carries a higher degree of risk. This can be useful for an investor who is looking for a potential higher return than a less risky investment, but who is not willing to accept the full degree of risk associated with it.

Since risk is a major factor in investing, risk-neutral measures are an important way for investors to assess the relative strengths and weaknesses of different investments. For instance, a stock-focused mutual fund and a bond-oriented fund may both have similar returns over the past few years, but the stock-focused fund may have more volatility due to potential market shifts. Risk-neutral measures can help investors determine which fund has the higher expected return and thus may be a better investment.

Risk-neutral measures can also help investors assess the potential returns of different types of investment products. For example, a bond fund may offer a higher expected return than a stock fund, but the bond fund may also carry higher risks due to the potential for default. Risk-neutral measures can help investors to consider the additional return that is attainable from investing in the bond fund if they are willing to accept the associated risk.

Risk-neutral measures are also important for weighing the potential return-to-risk ratio of derivatives, such as futures and options. These products can have complicated payoff structures that require a thorough understanding of the concept of expected value in order to accurately assess the potential outcomes. By using risk-neutral measures, investors can better understand both the potential reward and risk associated with such investments.

Overall, risk-neutral measures provide investors with the means to accurately compare investments, while also enabling them to make better informed decisions when assessing their risk tolerance and long-term objectives. By taking into account the additional return available with higher-risk investments, investors can make informed decisions that increase their chance of achieving satisfactory returns.