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    4.risk and Return Lesson

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    Sabarni Chatterjee
    Risk is defined as the possibility that actual returns will differ from expected returns. It includes the chance of losing some or all of an original investment. Risk is assessed quantitatively using metrics like standard deviation that measure volatility compared to historical averages. While no investment is risk-free, securities like Treasury bills and money market accounts have very little risk and form a baseline for analyzing risk. Risk has both systematic elements from broad economic and market forces that affect all investments, as well as unsystematic elements specific to individual companies. Return is the profit from an investment and typically higher risk means higher potential returns. Beta is a measure of systematic risk comparing an asset's volatility to the overall market, with values above 1 indicating greater volatility.

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    4.risk and Return Lesson

    Uploaded by

    Sabarni Chatterjee
    60 views8 pages
    Risk is defined as the possibility that actual returns will differ from expected returns. It includes the chance of losing some or all of an original investment. Risk is assessed quantitatively using metrics like standard deviation that measure volatility compared to historical averages. While no investment is risk-free, securities like Treasury bills and money market accounts have very little risk and form a baseline for analyzing risk. Risk has both systematic elements from broad economic and market forces that affect all investments, as well as unsystematic elements specific to individual companies. Return is the profit from an investment and typically higher risk means higher potential returns. Beta is a measure of systematic risk comparing an asset's volatility to the overall market, with values above 1 indicating greater volatility.

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    4.Risk and Return lesson

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    Risk is defined as the possibility that actual returns will differ from expected returns. It includes the chance of losing some or all of an original investment. Risk is assessed quantitatively using metrics like standard deviation that measure volatility compared to historical averages. While no investment is risk-free, securities like Treasury bills and money market accounts have very little risk and form a baseline for analyzing risk. Risk has both systematic elements from broad economic and market forces that affect all investments, as well as unsystematic elements specific to individual companies. Return is the profit from an investment and typically higher risk means higher potential returns. Beta is a measure of systematic risk comparing an asset's volatility to the overall market, with values above 1 indicating greater volatility.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    60 views8 pages

    4.risk and Return Lesson

    Uploaded by

    Sabarni Chatterjee
    Risk is defined as the possibility that actual returns will differ from expected returns. It includes the chance of losing some or all of an original investment. Risk is assessed quantitatively using metrics like standard deviation that measure volatility compared to historical averages. While no investment is risk-free, securities like Treasury bills and money market accounts have very little risk and form a baseline for analyzing risk. Risk has both systematic elements from broad economic and market forces that affect all investments, as well as unsystematic elements specific to individual companies. Return is the profit from an investment and typically higher risk means higher potential returns. Beta is a measure of systematic risk comparing an asset's volatility to the overall market, with values above 1 indicating greater volatility.

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    © All Rights Reserved
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    Download as pdf or txt
    of 8

    Risk and Return

    What Is Risk?
    Risk is defined in financial terms as the chance that an outcome or investment's actual gains will
    differ from an expected outcome or return. Risk includes the possibility of losing some or all of an
    original investment.

    Quantifiably, risk is usually assessed by considering historical behaviours and outcomes. In finance,
    standard deviation is a common metric associated with risk. Standard deviation provides a measure
    of the volatility of asset prices in comparison to their historical averages in a given time frame.

    Riskless Securities
    While it is true that no investment is fully free of all possible risks, certain securities have so little
    practical risk that they are considered risk-free or riskless.

    Riskless securities often form a baseline for analysing and measuring risk. These types of
    investments offer an expected rate of return with very little or no risk. Oftentimes, all types of
    investors will look to these securities for preserving emergency savings or for holding assets that
    need to be immediately accessible.

    Examples of riskless investments and securities include certificates of deposits (CDs),


    government money market accounts, and Treasury bills

    i. Elements of Risk:
    Various components cause the variability in expected returns, which are known as elements of risk.

    There are broadly two groups of elements classified as systematic risk and unsystematic risk.

    Systematic Risk:
    Business organizations are part of society that is dynamic. Various changes occur in a society like

    economic, political and social systems that have influence on the performance of companies and

    thereby on their expected returns. These changes affect all organizations to varying degrees. Hence

    the impact of these changes is system-wide and the portion of total variability in returns caused by

    such across the board factors is referred to as systematic risk. These risks are further subdivided into

    interest rate risk, market risk, and purchasing power risk.

    Unsystematic Risk:
    The returns of a company may vary due to certain factors that affect only that company.

    Examples of such factors are raw material scarcity, labour strike, management inefficiency,

    etc. When the variability in returns occurs due to such firm-specific factors it is known as
    unsystematic risk. This risk is unique or peculiar to a specific organization and affects it in

    addition to the systematic risk. These risks are subdivided into business risk and financial

    risk.

    Return

    Return, is the amount of money you receive from an investment. A return is often calculated as a

    percentage or ratio of the original investment, so that managers can measure and compare how well

    their investments are performing. Amount of return depends on a lot of different things, but the

    main driving force is risk. Typically, high-risk investments reap a higher rate of return than low risk

    investments.

    Portfolio return refers to the gain or loss realized by an investment portfolio containing several types

    of investments. Portfolios aim to deliver returns based on the stated objectives of the investment

    strategy, as well as the risk tolerance of the type of investors targeted by the portfolio

    Return and Risk of Single Security


    Measurement of risk:
    Beta of Security
    Beta is a measure of the volatility—or systematic risk—of a security or portfolio compared to the
    market as a whole. Beta is used in the capital asset pricing model (CAPM), which describes the
    relationship between systematic risk and expected return for assets (usually stocks). CAPM is widely
    used as a method for pricing risky securities and for generating estimates of the expected returns of
    assets, considering both the risk of those assets and the cost of capital.

    The calculation for beta is as follows:


    How to Calculate Beta
    To calculate the beta of a security, the covariance between the return of the security and the return
    of the market must be known, as well as the variance of the market returns.

    Covariance measures how two stocks move together. A positive covariance


    means the stocks tend to move together when their prices go up or down. A
    negative covariance means the stocks move opposite of each other.

    Variance, on the other hand, refers to how far a stock moves relative to its
    mean. For example, variance is used in measuring the volatility of an
    individual stock's price over time. Covariance is used to measure the
    correlation in price moves of two different stocks.
    Types of Beta Values
    Beta Value Equal to 1.0
    If a stock has a beta of 1.0, it indicates that its price activity is strongly correlated with the market. A
    stock with a beta of 1.0 has systematic risk. However, the beta calculation can’t detect any
    unsystematic risk.

    Beta Value Less Than One


    A beta value that is less than 1.0 means that the security is theoretically less volatile than the
    market. Including this stock in a portfolio makes it less risky than the same portfolio without the
    stock

    Beta Value Greater Than One


    A beta that is greater than 1.0 indicates that the security's price is theoretically more volatile than
    the market.

    Negative Beta Value


    Some stocks have negative betas. A beta of -1.0 means that the stock is inversely correlated to the
    market benchmark.

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