Risk and Return

S.Visalakshmi,VIT

What is a return?
Return can be defined as excess over initial
investment earned over a period of time.
Return is the actual income received plus any
change in market price of an asset/
investment.
(In case of shares, rate of return would consist of
dividend yield and capital gain yield)

S.Visalakshmi,VIT

Return on a Single Asset

Total return = Dividend + Capital gain
P1=Security price at closing/ending period
P0=Security price at opening/beginning period
Rate of return Dividend yield Capital gain yield
DIV1 P1 P0 DIV1 P1 P0
R1

P0
P0
P0
S.Visalakshmi,VIT

Return on a Single Asset

Year-to-Year Total Returns on HUL Share
50
40.94
36.99

40

Total Return (%)

30

21.84

20

15.65

12.83

10.81

10

2.93

0
-10
-20

1998

1999

2000
-6.73

2001

2002

2003

2004

-16.43

-30

-27.45

-40
Year

S.Visalakshmi,VIT

2005

2006

2007

Average Rate of Return

The average rate of return is the sum of the
various one-period rates of return divided by
the number of period.
Formula for the average rate of return is as
follows:
1
1 n
R = [ R1 R2 Rn ] Rt
n
n
t =1

S.Visalakshmi,VIT

What is risk?
Risk of returns is the variability in rates of
return.
The variability of rates of return may be
defined as the extent of the deviations (or
dispersion) of individual rates of return
from the average rate of return.
There are two measures of this
dispersion: variance or standard deviation.
Standard deviation is the square root of
variance
S.Visalakshmi,VIT

Risk of Rates of Return: Variance and

Standard Deviation

Formulae for calculating variance and

standard deviation:
Standard deviation = Variance

n
1
Variance 2
Rt R

n 1 t 1

S.Visalakshmi,VIT

Expected Return : Incorporating Probabilities in

Estimates

The following formula can be used to

calculate the variance of returns:
2 R1 E R 2 P1 R2 E R 2 P2 ... Rn E R 2 Pn
Ri E R 2 Pi
n

i 1

S.Visalakshmi,VIT

Risk preferences

S.Visalakshmi,VIT

Expected Risk and Preference

A risk-averse investor will choose among
investments with the equal rates of return, the
investment with lowest standard deviation and
among investments with equal risk she would prefer
the one with higher return.
A risk-neutral investor does not consider risk, and
would always prefer investments with higher returns.
A risk-seeking investor likes investments with higher
risk irrespective of the rates of return. In reality, most
(if not all) investors are risk-averse.
S.Visalakshmi,VIT

Beta
Beta measures the risk (volatility) of an individual
asset relative to market portfolio.
Beta is the covariance of the assets return with the
market portfolios return, divided by the variance of
market portfolio.
Assets with beta less than one are called defensive
assets.
Assets with beta greater than one are called
aggressive assets.
Risk free assets have a beta equal to zero.
S.Visalakshmi,VIT

 Beta=[n ( XY)- X Y] / [n (X ) - (X) ]

S.Visalakshmi,VIT