Economics Time Value Of Money Questions Medium
In the context of time value of money, the concept of risk-neutral refers to the assumption that individuals or investors are indifferent to risk when making financial decisions. It assumes that individuals do not require any additional compensation for taking on risk and are only concerned with the expected return on their investments.
Under the risk-neutral assumption, individuals are assumed to have a neutral attitude towards risk and make decisions solely based on the expected value of future cash flows. This means that they assign the same value to a certain amount of money today and the same amount of money in the future, regardless of the level of risk associated with the investment.
For example, if an individual is given the choice between receiving $100 today or $100 one year from now, the risk-neutral individual would be indifferent between the two options. They would not require any additional compensation for waiting one year to receive the money, as they do not consider the risk of not receiving the money in the future.
The risk-neutral assumption is often used in financial models and calculations, such as discounted cash flow analysis, to simplify the decision-making process and facilitate comparisons between different investment options. However, it is important to note that in reality, individuals have varying attitudes towards risk, and the risk-neutral assumption may not accurately reflect their behavior.