Which of the following best summarizes the purpose of understanding absolute and relative risks?

Understanding absolute and relative risks is essential for making more informed investment decisions because it allows investors to assess the potential returns in relation to the risks involved. Absolute risk refers to the actual risk level of an investment, while relative risk compares the risk of one investment against another or against a benchmark.

By grasping these concepts, investors can better evaluate their risk tolerance, make comparisons between various investment options, and identify opportunities that align with their financial goals. This understanding is crucial for developing investment strategies that aim for optimal risk-adjusted returns.

In contrast, focusing solely on identifying the least costly investments does not consider the associated risks, which could lead to poor decision-making. Evaluating liquidity options is about how quickly investments can be converted to cash, without directly addressing the risks. Similarly, establishing credit ratings pertains to assessing the creditworthiness of borrowers and does not incorporate the broader investment risk context. Thus, the essence of assessing absolute and relative risks is truly anchored in making informed investment decisions.