Risk And Return

Risk and Return

Risk and Return Return refers the amount of total monetary benefits a investors receive from a security.

( Pt − Pt −1 ) + Div Ri = Pt −1 Where, Pt is price of security in time period t, Pt-1 is price in last time period, Div is dividends.

Return Calculation Time

May-07

Reliance Ind. Opening Price Closing Price Div. 1752.0 1760.0 10.0 Return= {[(Pt-Pt-1)+Div ]/Pt-1}*100 {[(1760-1752)+10 ]/1752}*100 = 1.04%

Risk Variation in the mean rate of return exhibits risk. Volatility in the stock market indicates risk which affects the value of the stocks.

Total Risk

Systematic Risk

Unsystematic Risk

Market Risk

Business Risk

Purchasing Power Risk

Financial Risk

Interest Rate Risk

Forex Risk

Systematic Risk  Market Risk-Market risk refers to that portion of total variability in the return caused by factors affecting the whole market. Economic, political and sociological changes are sources of this type risk.  Purchasing Power Risk- Purchasing risk is associated with inflation and deflation. If an investor gets 5 percent rate of return and prevailing inflation is 5.5 percent, it means that investor is realizing 0.5 percent loss on the investment over the period of time.  Interest Rate Risk- Interest rate risk is associated with fluctuations in rate of return caused by variation in general interest rate. Interest rate risk is becoming prominent as not only domestic interest rate but also interest rate prevailing in the international market can cause volatility in the stock market.  Foreign Exchange Risk-Foreign Exchange Risk is caused by changes in foreign exchange rate.  Market risk can not be diversified by enlarging the portfolio. This risk affects the market as a whole and each stock seems to co-vary in the same direction with the emergence of this risk.

Unsystematic Risk  Business Risk- Business risk, emerges because of operating conditions, variability in business conditions, dividend decisions etc.  Financial Risk- The other type of non-market risk is financial risk caused by the way a firm finances its activities or expansion plans. If a firm raises debt in the market it increases its obligation to pay fixed amount of fund, viz., interest to the debtors. Investors perceive it risky to invest in those stocks whose debt equity ratio is high.  Non-market risk is specific and associated with individual stocks. This risk can be eliminated by enlarging and diversifying the portfolio by holding different stocks of different industries.

Portfolio Return and Risk Portfolio Return=

N

R p =∑ wi Ri i= 1

N

Portfolio Risk =

σp =∑wiσi i =1

N

Portfolio Market Risk=

σp = ∑wi βi i =1

Portfolio Return and Risk Total Fund=1,00,000 SBI Return 2% Risk (Stdev) 2

ABB 3% 4

Money Invested 10,000

20,000

Portfolio Return= 0.10*2 +

0.20*3

Portfolio Risk= 0.10*2

0.20*4

+

TCS 2% 3 25,000 +

Wipro 5% 2

Infosys 6% 3

25,000

20,000

0.25*2 + 0.25*5

+ 0.25*3 + 0.25*2

+ 0.20*6 =3.75% +0.20*3 = 2.85%