1. SWARNAM S/UNIT 1/RISK & RETURN - CBS
RISK AND RETURN
SWARNAM S
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

2. INTRODUCTION-RISK & RETURN
Individuals invest their money in different types of financial assets like government securities, bank deposits, debentures, preference shares and equity shares
The primary objective in making these investments is to get benefits in future period
The benefits are in form of interest, dividend and capital appreciation
All securities do not yield the same return
For example: Return on Government Securities is low, Equity Shares yield higher rate of return
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

3. SWARNAM S/UNIT 1/RISK & RETURN - CBS
RISK AND RETURN
Risk
-- Risk refers to the degree of variability of actual return from the expect return
-- Greater the variability, Greater the risk
-- Fewer the variability, Fewer the risk
-- Example: An investor who has invested in government securities will definitely get the expected return
-- However, if he invests in equity shares, the actual return may be greater or less than the expected return
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

4. SWARNAM S/UNIT 1/RISK & RETURN - CBS
Contd…
For Example, Mr. A invested in the security X with the expectation of income of Rs.5,000. But he gets only Rs.3,000 on return. Though he is getting income of Rs.3,000 from the investment yet it is risky investment as actual return is less than expected return
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

5. SWARNAM S/UNIT 1/RISK & RETURN - CBS
Return is the motivating force, inspiring the investor in the form of rewards, for undertaking an investment
The objective of any investor is to maximize expected returns from his investments
Types of Return:
-- Realized Return : ex-post
-- Expected Return : This is the return that investors anticipate or expect to earn over some future period
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

6. SWARNAM S/UNIT 1/RISK & RETURN - CBS
Components of Return
Current Return - Periodic Cash Inflow
Capital Return Price Appreciation or Depreciation
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

7. SWARNAM S/UNIT 1/RISK & RETURN - CBS
Example: Consider an initial investment in the stock of Reliance, Current selling price at a price of Rs.500 per share. An investor buys 100 shares making an initial investment of Rs.50,000. Assume that investment is made for one year, after which the investor would make an exit by selling the shares. Assume that Reliance declares a dividend of Rs.10 per share during one year. Further at the end of one year the share price is Rs.600 per share
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

8. SWARNAM S/UNIT 1/RISK & RETURN - CBS
Contd..
Total return = Dividend yield + Capital gain
Total return =100*10+100*100= 1,000+10,000
Total return = 11,000
Total % Return = Dividend yield + Capital gain* 100
Initial Investment
Total % Return = 22%
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

9. SWARNAM S/UNIT 1/RISK & RETURN - CBS
Rate of Return
The return on security refers to the total gain or loss over a given period- say one year
Rate of Return is calculated as a percentage of initial investment
In Case of Debentures, the return consists of interest
In Case of Equity Shares, the return consists of dividend and capital gains
Variability of Return
The degree of deviations
The fluctuations are caused by volatile changes in the market
Measurement of Return
Standard Deviation
Variance
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

10. SWARNAM S/UNIT 1/RISK & RETURN - CBS
CAUSES OF RISK
Wrong Decision – What to invest in
Wrong timing of investment
Nature of Instruments
Creditworthiness of Issuer : Government Securities are creditworthy than private sector
Maturity Period
Amount of Investment
Nature of Industry or Business
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

11. SWARNAM S/UNIT 1/RISK & RETURN - CBS
TYPES OF RISK
Unsystematic Risk
Systematic Risk
Market Risk
Interest Rate Risk
Purchasing Power Risk
Business Risk
Financial Risk
Internal Risk
External Risk
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

12. SWARNAM S/UNIT 1/RISK & RETURN - CBS
Systematic Risk
-- Variability in a security’s returns associated with Market or Economy
-- The investor cannot avoid this risk (uncontrollable)
-- It is critical to all investors
-- Effect of these factor is to put pressure on all securities in such a way that price of all securities move in same direction
Example:
-- The Government changes the interest rate policy
-- Massive changes in tax rate
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

13. SWARNAM S/UNIT 1/RISK & RETURN - CBS
Contd…
Unsystematic Risk (Unique Risk) – Specific to a Company
-- Variability in security’s returns not related to overall market
-- It is also called unique risk
-- Risk arises due to factors specific to the company
Example:
-- The company workers declare strike
-- R&D experts leaves the company
-- The Company is unable to obtain adequate raw materials
-- Loss of Big Contract
-- Changes in consumer preference
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

14. SWARNAM S/UNIT 1/RISK & RETURN - CBS
SYSTEMATIC RISK
Market Risk : Bull and Bear Market ; Tangible Events (earthquake, war, terrorist attack, fall in value of currency) and Intangible Events (overreaction to tangible events)
Interest Rate Risk: If the interest rate moves up, the price of the bond declines and vice versa
Inflation/Purchasing Power Risk - Fixed income securities, such as bonds subject investors to the greatest amount of purchasing power risk. The rise in price penalizes the return to the investor. The inflation may be demand pull or cost push inflation
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

15. SWARNAM S/UNIT 1/RISK & RETURN - CBS
UNSYSTEMATIC RISK
Business Risk
Internal Risk (Controllable)
-- Fluctuations in sales
-- Technological Problem
-- Personnel Management – Strikes, Dishonesty of employees, Accidents or Death inside the factory
-- Fixed Cost (during the period of recession or low demand -high risk)
-- Single Product
External Risk (beyond control)
-- Natural Factors, Market Fluctuations, Regulatory Factors and Political Factors
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

16. SWARNAM S/UNIT 1/RISK & RETURN - CBS
Contd…
Financial Risk
-- Credit Risk (non-payment or delayed payment of interest or principal)
-- Currency or Foreign Exchange Risk (variability in returns caused by currency fluctuations)
-- Country Risk (When a country defaults on obligations) it affects all financial instruments ; economic instability and political instability
-- Liquidity Risk – difficulty in selling , selling at discount rate
-- Valuation Risk - if valuation is too high
-- Business and Technology Risk (back pagers & typewriters )
-- Concentration Risk (invested in single asset is high risk)
-- Information Risk (outsiders)
-- Execution Risk (time gap between seeing & selling )
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

17. RELATIONSHIP BETWEEN RISK AND RETURN
The risk and return are directly variable
Returns from securities are not certain or fixed
Risk means possibility of losing some, even all of your original investment
The total risk consists of two parts: systematic risk and unsystematic risk
Market risk due to general factors it affects all the securities
Unique risk due to the factors of the company. It can be reduced
The risk is measured by Standard Deviation
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SWARNAM S/UNIT 1/RISK & RETURN - CBS

18. SWARNAM S/UNIT 1/RISK & RETURN - CBS
PORTFOLIO INVESTMENT
The investor should not hold all the eggs in one basket
The investor should hold a well diversified portfolio
Hence, it is advisable to invest in a number of securities
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SWARNAM S/UNIT 1/RISK & RETURN - CBS