![Y P(Y) Y* P(Y) Y 2 * P (Y)
7 0.25 1.75 12.25
15 0.50 7.50 112.50
23 0.25 5.75 132.25
Total 1.00 15.00 257
S.D = S Y2 * P(Y) – [S Y*P(Y)]2
S.D = 257 – (15) 2 = 5.66 rupees](https://image.slidesharecdn.com/riskandreturnmeasurement-170829180424/85/Risk-and-return-measurement-17-320.jpg)
Risk and return measurement
- 2. What is a risk ?
- 3. According to dictionary meaning : The existence of volatility in the occurrence of an expected incident is called risk .Higher the unpredictability greater is the risk.
- 4. Wrong method of investment Wrong timing of investment Wrong quality of investment interest rate risk Maturity period or length of investment Terms of lending National and international factors Natural calamities
- 5. Systematic risk Unsystematic risk Market risk Interest rate risk Purchasing power risk Business risk Financial risk Default credit risk
- 6. Systematic risk refers to that portion of variation in return caused by factors that affect the prices of all securities .This risk cannot be avoided or ignore .The effect of return causes the prices of all individual securities to move in the same directions .systematic risk arises due to the following factors:
- 7. a. Market risk : Variations in prices sparked off due to real social, political and economic events is referred to as market risk .Market risk arises out of changes in demand and supply pressures in the market following the changing flow of news or expectations . b. Interest rate risk :Generally price of securities tend to move inversely with changes in the rate of interest. The market activity and investor perceptions are influenced by changes in the interest rate which turn depend on the nature of stocks,bonds,loans etc maturity of the periods and the credits worthiness of the issuer of the securities.
- 8. Purchasing power risk : uncertainty of purchasing power is referred to as risk due to inflation. Inflation arouses optimism since all the prices group and that lead to higher incomes. But the effect of this hike in incomes increases and cost of production due to wage rise, rise in prices of raw material etc. There is a possibility of prices of desired goods and services going up due to inflation .
- 9. Unsystematic risk refers to that portion of the risk which is caused due to factors unique or related to a firm or a industry. This risk is company specific risk and can be controlled if proper measures are taken. It is caused by the factors like labors, shortage of power, recession in particular industry etc.
- 10. Business risk : Business risk can be internal as all as external. Internal risk is caused due to improper product mix ,non availability of raw materials, absence of strategic management etc. External risk arises due to change in operating conditions caused by conditions thrust upon the firm which are beyond its control eg;business cycle, government controls, international market conditions etc. Financial risk : This risk is associated with the capital structure of a company. A company with no debt financing has no financial risk. The extent of financial risk depends on the leverage of the firms capital structure. Credit or default risk :The credit risk deals with the probability of meeting with a default. It is primarily the probability that a buyer will default. Proper management can reduce the chances of non payment of loan .
- 12. Standard deviation Beta
- 13. It is a measure of the value of the variables around its mean or it is the square root of the sum of the squared deviation from the mean divided by the number of observances . The arithmetic mean of the return may be same for two companies but the return may vary widely. Or Standard Deviation as a Measure of Risk. The standard deviation is often used by investors to measure the risk of a stock or a stock portfolio. The basic idea is that the standard deviation is a measure of volatility: the more a stock's returns vary from the stock's average return, the more volatile the stock.
- 17. Y P(Y) Y* P(Y) Y 2 * P (Y) 7 0.25 1.75 12.25 15 0.50 7.50 112.50 23 0.25 5.75 132.25 Total 1.00 15.00 257 S.D = S Y2 * P(Y) – [S Y*P(Y)]2 S.D = 257 – (15) 2 = 5.66 rupees
- 18. STOCK A STOCK B Expected Return 15 rupees 15 rupees Standard Deviation 1.41 rupees 5.66 rupees Comparing the two stocks, we see that both stocks have the same expected returns. But the SD or risk is different. The S.D of stock B > S.D of stock A We can say that the return of stock B is prone to higher
- 19. CV is a measure of relative risk. It tells us the risk associated with each unit of money invested. Formula: CV = s(x) / E(X)
- 22. R = Rf + ( Rm – Rf )*b
- 23. Beta describes the relationship between the stock return and index return. Beta describes the systematic risk Beta =+1.0 one percent change in the market index return causes exactly one percent change in stock return. It indicates that the stock moves in tandem with the market . Beta =+0.5 one percent change in the market index return causes exactly 0.5percent change in stock return. It indicates that the stock is less volatile compared to the market. Beta =+2.0 one percent change in the market index return causes exactly 2 percent change in stock return. It indicates that the stock is more volatile. When there is a decline of 10%in the market return the stock with beta 2 would give a negative return of 20%.
- 24. Suppose the risk free rate of the security is 6% The market rate is 12% and the beta is 1.25, Then the required rate of return for the security would be R = 6 + (12 – 6) * 1.25 R = 6 + 7.5 R = 13.5% Reconsider the above example but suppose that the value of B = 1.60. Then the return would be: R= 6 + (12 – 6)*1.60 R= 6 + 9.6 R= 15.6% So, we see that greater the value of beta, the greater the systematic risk and in turn the greater the required rate of return.