Analysis of Return and Risk ‘earning Outcomes Aer swiyin this hope, you should be able to understand Concept of Return, Concept of Risk and its Types, Impact of Inflation and Taxes on Return, vv Vv Measurement of Risk and Return. 10.1 Introduction An optimum or sound investment decision is one that provides comparatively higher return than associated degree of risk. This chapter deals with the concept of risk and return, their relationship in the context of investing decisions. These two concepts (risk and return) are of vital concern to investors, so, before taking up the issue of investing in stocks and bonds, let’s look more closely at the risks of investing and the various components of return. We can't consider the return on an investment without also looking at its risk — the chance that the actual return from an investment may differ from (‘.e., fall short of) what was expected. Risk and return are inseparable. It is not possible to expect return without bearing the risk. Equally important, we'll see how these two components can be used together to find potentially attractive investment vehicles. 10.2 Concept of Return the return is the basic motivating ce and the principal reward in the investment decision process. In Simple words, return is the benefit or gain to an investor resulting from the investment process. So thej 108 || Personal Finance and Planning ins of dividend, interest, bonus, c4) return froni an investment is the expected cash inflows in ter ete available to the investor from investment. ‘There are two types of return — ({) realised return, (ii) expected return. (i) Realised return: ‘This is basically the historical return of an Lies era te investment is the annual return of an assets over several years: which hay earned by an investor over the holding period. (ii) Expected return: This is the predicted or estimate some future ivefaeeae say that the return which an investor anticipates to carn ov meat nigel ‘| ‘ ‘onal investors use historical returns, a Paid say in one year. Research analysts and professional : nd a ite future rates of return, "bi industry and economic data, to estimal i i Juate various assets, such as stocks Rs return and estimated returns to eval I fe can use actual returi tegory. This evaluation process helps you pick 7% d return and may or may not occur, q, as well as different securities within each asset ca a ; i ion. mix of securities to maximize returns during your investment time hori7 1 10.3 Measurement of Return 10.3.1 Holding Period Return/Reolised Return “The return may be measured as the total gain or loss to the holder over a given period of time ang be defined as a percentage return on the initial amount invested The return can be measured as follow: Interest/Dividend + Price change in assets over the period rl Holding Period Return = ~~" chase price ofthe asset 1 _ YD+(B-R) 2 _ PD B=) Perr, = Revenue return + Capital return (Price changes) Where, I= Investment; D = Dividend; P, = Beginning price; P, = Ending price. Total return is divided into two parts revenue return and capital return. Revenue return is the component of the return. It refers to the periodic cash inflow or income from investment in the forn interest or dividend. Capital return or price changes refers to the difference between the cost price of investment and the rate at which it can be or is sold. It is the difference between the beginning price ending price of the investment. 10.3.2 Expected Return (Ex-Ante Return) ‘The average return based on a series of historical returns may not be useful in making future predict about expected returns. Therefore an investor may have a number of probable returns and adistribution» construct ® pro calculated ‘analysts can actually i ey Se ae ‘outcomes. expected return cal m ion of rate of return) by the OT of the the results. ‘Simply, itis the weighter sible return with the respective utcom cp esPere pilities 10 the 2 ong PO comes (EXPECT . .d summing ipiing the PO he i” return. wie ged retur” pec ofoceurring | fe ie return OF security 1 5 aber of YM e of Return . mn 4 pea Ret ation adjusted return, Rate “finflation may also reduce theincole Garay by geo oT inflation rate should also be considered at the time of making the invest nen red 50 reap betwee? "he real rate of return, nominal rate of return and inflation cat sai the relation, sons " oasis Nominal Rate of Return = Inflation Rate Real Rate of Return pee 1+ Inflation Rate al rate of {the rate of interest is 10% and the rate of inflation is 6% then the re: For example: ‘Assume if iid be: o (0.10=0.06)_ 0.04 _ 99377237 = +0106) 0377 = 3.77% pealRate ofRetU = 779.96) 1.06 0p so instead of getting 10% return you aawcilly soifthe inflation in the market is 6 got 3.77%. 105 Impact of Taxes on Investment Decision fowever the rates of tax differs from investment to from investment are also exempt from tax such as public provident fund, Tax rnd paid to equity shareholders are subject to tax to shareholders. However, are taxable in the hand of investors. Similarly the capital gain hort term and long term capital gain depending upon the idevat tax provisions, ‘ihe shareholders are liable to pay long term capital gain tax on sale of shares ‘910% over and above €1 lakh. The short term. capital gain on sale of shares is also tax @ 15%. Even now thes of mutual fund units are also liable to tax under the short term and long term capital gain. An ei ae the tax-implication in making investment decisions. An investor must find out Berd out ihe mens Bio ey ihe oe ee bg considered for decision making. In see our from an i estment, the tax implications of capital gains/losses should easure of tax planning, investors can time the sale of investments. name fom investment are also subject fo ta H investment, Some income ‘nee bonds etc. The divider ‘terest in case of most of the investment rayako be required to be classified into110 || Personal Finance and Planning ge ‘The income tax adjusted return may be calculated as follows: ‘Taxable rate of return Coupon rate (1 Income tax adjusted return (net return) = ‘Where, t= tax rate. E For example, if Mr. X is earning 20% interest on bonds and his income is subject to tay ex after tax rate of return is: After tax return = 0.20 (1 = 0.30) = 0.14 or 14% Incase the investor has been offered both types of options, tax free and taxable, either he ca, the taxable into income tax adjusted return or tax free return into tax equivalent return (before order to have the same ground of comparison. ) Tax Free Return 1-Tax Rate For example, if Mr A is earning 8% tax free interest on debenture and his income is subj, @20%. In this case the taxable equivalent return is Te ivalent return = 2% uivalent return = ———— I A (10.30) : 10.6. Risk Although return is an important aspect of determining whether an investment is appropriate, its Cy important to consider the risk associated with an investment. Each type of investment offers adj, level or type of return; similarly, each investment has different associated risks. Risk can be defined as the variability in the expected return. Risk is the likelihood that actual Tet will be less than historical and expected returns. Risk arise because returns are neither certain not Pi and cannot be predicted in advance. It arises due to the fact that actual returns will be different fg expected returns. However, the level of risk will vary from investment to investment. The risk m be considered as a chance of variation in return. Investment having greater chances of variations 4, considered more risky than those with lesser chances of variations. Risk factors include market volatility, inflation and deteriorating business fundamentals, Finang) market downturns affect asset prices, even if the fundamentals remain sound. Inflation leads to alos buying power for your investments and higher expenses and lower profits for companies. Tax equivalent return = = 0.1143 = 11.43% Business fundamentals could suffer from increased competitive pressures, higher interest expenss quality problems and management inability to execute on strategic and operational plans. Wel fundamentals could lead to declining profits, losses and eventually a default on debt obligations. Uncertainty and Risk Uncertainty is the core concept of risk. It is often used in connection or interchangeably with tit term risk. The meaning of uncertainty refers to a state of mind which is characterised by doubt d to lack of knowledge about what will or will not happen in the future. In the case of risk we can ass the probability for happening or not happening of an event on the basis of facts and figures availof asin case of uncertainty we cannot assign probability for the happenin ae y Wailable. While risk isa state of nature, uncertainty ios nee ie al figures are no! atic risk. etely. It refers to th Jc — Systematic risk and Unsystem: ic that is impossible to avoid comp! ‘ed by the factors affecting all the firms. te policy of the government, ‘which affects almost all the ther, You can do either folio diversification isk or f ris! a fat portion of es e type of ris jes jen which is caus include inflation, recessions, interest rat : ples Of si policys tx reforms and war. These are the factors Factors is to cause the prices ofall securities to move toge rotect yourself from systematic risks, and no amount of port ; tie risk is also called the non-diversifiable risk or general ri ythit re ie oop eric 8K: THE systema smpanies or industries. This risk poet ic vik is the visk that affects an isolated group of co} n i paste tuations in returns from an investment due to factors ‘which are specific to the partic lar the market as @ ‘whole. $o these are the factors which are controllable by the firm. This specific issues like labour, management, asset etc that affect a specific firms and not escamany SPC*" pharmaceutical company’s stock plummet after the news that the company ona hole: A Pret Fcorona isan example of unsystemati sk Labour unrest and corporate arompany axe also the example of unsystematic risk, Diversification substantially peek or eliminates tunsystematic risks. As the tunsystematic risk results from random events that tend this risk is random in nature. foan industry or a firm, phe unique in en ty ystematic Fisk i ing. Sources of Risk tribute to variations in return from an investment, Each of these ‘ere are different sources that cont He onaates an element ofrisk The diferent (YPes of risk in investment are as follow: 1) Business Risk ‘When investing in a company, ssksand profits or even to stay in asis more often the case, to poor man seroundng the firms cash flows and subseque tht are subject to high degrees of business ris _ vil eratic earnings, and can experience substanti you may have to accept the possibility that the firm will fail to maintain ray tas Such failure is due either to economic or industry factors nagement decisions. Business risk is the degree of uncertainty nt ability to meet operating expenses on time. ‘Companies sk may experience wide fluctuations in sales, may have al operating losses every now and then. {il Financial Risk cial i feral concerns the amount of debt used to finance the firm as Biba ede silent cach lows to meet these obligations on time (0 get a handle on a firm's financial risk. As a rule, companies ¢ well as the possibility that the Look to the company's balance hat have little or no long- EE | | | |term oT articularly so if the compan, I WW dal risk, This is part h debt are fairly low in finan hy ‘The problem with debt financing is that it creates principal and interes Obl hey picture, ‘met regardless of how much profit the company is generating, (iil) Market Risk havior of investors in the securities markets ¢j eon eran er sae itis caused due to the herd-mentality of, inven Jeag 6 BGR GRATE Eloy/the discon of the markt, Thee Brice changes can pt 8 intrnse actors as wel as to changes in politica gconomic, and social cong "de and preferences, Essentially, market risk is reflecte Hie PEeevoalty of Security, ley the price of a security the greater its market risk. If the market is falling then even ae stock flin prices This decline in share price due to Inarket factors is termed a marker od onsttute almost 2/3"! of total systematic risk. Therefore sometime, Systematic risk ae a market risk Mra ny {iv) Purchasing Power Risk Changesin the general level of prices within the economy also Produce UEChasing poy of rising prices (inflation), the purchasing power of the money declines, This mee Wer righ, a of money can buy smaller uantity of goods and services due to Icrease in prices os thes, ang Income does not increase in times of rising inflation, then the investor is actually pet herefore ify income in real terms, In general, investments (such ve Stocks and real estate) who 8 ow with general price levels are most profitable during periods rising prices, wheres, bonds) that provide fixed returns are Preferred during periods of low or dk Hae {v) Interest Rate Risk n rate/Interest rate) | the bond Bond Price = 5 —————"POn rate/Interest rat ee ay, interest rate x Par value ofAnalysis of Return and Risk || 113 ot interest rate decline to 8% then the bond price will be: ag 10% ice = ——x100 = 212: Bond Price = “597 5 ypthe on for this is if the market interest rate increases, we will not find any buyer for this bond ghee nd will provide less interest income than market interest rate, Investor will prefer to invest ease et rather than bond. Therefore this bond become attractive only ifit prices lower than 2100. jt increase it interest rate makes bond price to fall and vice versa. The prices of fixed income 3 hen interest rates increase, giving investors rates of return that are competitive with wl Jevels of interest income. Changes in interest rates are due to fluctuations in the ie Pp cot ering higher demand for money. exchange 2 erate Ti ate Risk sk is the uncertainty. associated with changes in the value of foreign currencies. This type sacar affect those securities which have foreign exchange transactions or exposures such as export Bo sor compas which use imported raw material ot products. For example if rupees I say from €75 per USD to Z80 per USD then the value of imported material will increase dep n though there is no change in the quantity of imported material. Therefore forms of Tupees even 1 here i se ompany importing this material will have to spend more rupees to buy dollars for paying for the imported material (vii) Liquidity Risk ‘he risk of not being al ble to liquidate (i.e., sell) an investment conveniently and at a reasonable price ‘scalled liquidity (or marketability) risk. In general, investment vehicles traded in thin markets, where soply and demand are small, tend to be less liquid than those traded in broad markets. However, to seliquid, an investment not only must be easily salable but also must be so at a reasonable price. The liquidity ofan investment can generally be enhanced merely by cutting its price. For example, a security reentlypurchased for 21,000 wouldn't be viewed as highly liquid ifit could be sold only at a significantly reduced price, such as €500. Vehicles such as shares and mutual funds are generally highly liquids others, suchas an isolated or disputed land, are not. 109 Types of Investors On the basis of investor preference or attitude towards risk, they are classified into three gr averse, isk seeker and risk neutral investors. ‘oups risk owever, may be ready to take risk if the return. ‘or every additional units of risk, they demand yme investors are more risk averse Tess risk averse investors and are + Risk Averse: ‘These investors try to avoid risk, h available for taking extra risk is commensurate. F higher and higher compensation, in terms of higher returns. So! investors also known as conservative investor. Some investor are called aggressive investors. i ence These investors requires just a sufficient return for taking isk They make thei ca Pe decisions purely on the basis of Return. They. do not consider risk. They want no extra fora given level of risk. Risk is not an important factor for these investors.114 || Personal Finance and Planning ifit is notaccompanied by higher n bling just for the sake or n iS + RiskSeekers: They undertakes more and more risk eve! ‘They are the risk lover and engage in fair games as well as ga" excitement. 10.10 Risks in Different Types of Investment ject to different kinds of risk. The affect each of them are: it e three major investm, Different kinds of investments are subj lent ¢} are cash, bonds, and stocks. The risks that typically (i) Cash ‘The chiefriskis purchasing power risk principal, as measured by purchasing power wil €e i ina ea investment that pays you 4% while the inflation rate is 3.75 power if your 4% income is subject to tax. e return on the investment or value of inyeg 1. Here’san example: Ifyoy Ne Sy — the risk that th will decrease due to inflatior 5%, you'll actually lose pureh, Bonds | “The investment in Bonds has two outcomes: | « The interest rate will beat inflation. The Interest will be paid and you'll get your money back. the relevant risks here are interest rate risk (i.e. will interest rates rise, then, .d default risk (will the bonds’ issuer pay you back). " Consequently, reducing your bonds’ value) an‘ (iii) Shares “The investor invests in shares of a company on the basis of issuing company’s performance over time, Th, stock’ price can be valued on the basis of what the market expects the company to pay each shareholig in the fature, That value is based on the company’s expected profits. If the profits turn out to be love: or higher than expected, you bought the stock for the wrong price. In addition, the Stock price mayhy affected by any economic consideration affecting the company, the industry, the region, or the ene stock market. This is referred to as market risk. Certain indicators can help you assess to what ext | companies will be subject to market risk. One useful concept for this purpose is beta. Analysts determine a stock’s beta by comparing the stock’ historical price changes to that of the market. A stocks bes measures the volatility of its price changes in relation to the stock market's volatility, as represented the market index. 10.11 Measurement of Total Risk Risk is defined as the variability in expected returns. This variability can be estimated using varios statistical methods like Range, Standard Deviation and Variance. (i) Range: It is defined as the difference between the highest and lowest possible returns from#t investment. More the range, higher will be the variability. Hence greater will be the risk. (ii) Variance or standard deviation: The Square root of the variance is standard deviation. Standa! deviation of securities can be calculated by measuring the extent of deviations of individual of return from the average rate of return. | 3ee 145 RY (In case when only return of the series is giver) where, pie ireturn n= Number of observation R = Mean return soefficient of Variation: Coefficient of variation is a relative measure of dispersion. Standard e does not consider the dispersion of expected return in relation to expected values. We cannot deal syjation to compare the risk of two or more investment. The measure of standard deviation dard dey 4 seta proved upon By converting it into coeficient of variation, The higher the CY the more risky om nvestment is: the _ Standard Deviation _o CV= Mean Return R 10.12 Measurement of Systematic Risk risk can be estimated by the sensitivity of security’s return with respect the market return. ty can be calculated by beta coefficient (f). It measure the risk of one security/portfolio in ne jonto market risk. The market risk is measured by fluctuation inthe market benchmark, i.e» market i. segs Nifty, Sensex. Shares whose B is equal to 1 isas risky asthe market index or market portfolio. inl hose is more than 1 aze considered as more risky than the market and share whose is less ne 1 are considered less risky. B can be negative also. It means that the security returns are moving in the opposite direction of the market return. gpsematic theses Beta — change in price of stock for a given period % change in market index for a given period 10.13 Valuation of Unsystematic Risk Unsystematic risk is that component of total risk which is not explained by the market. As we all know that total risk is equal to systematic risk and unsystematic risk. We know that the standard deviation (risk) is the square root of variance and the two root terms cannot be added together. Therefore, in order to find out unsystematic risk, total risk is expressed in terms of variance. Unsystematic risk can be calculated by subtracting systematic variance from the total variance. Unsystematic Variance = Total variance - Systematic Variance ‘The unsystematic risk in terms of standard deviation will be the square root of the unsystematic variance.116 || Personal Finance and Planning 10.14 Risk-Return Trade Off ‘The different types of investments have different degree of risk and the required rate of a government securities have rate of return equal to the risk-free rate, As the risk increases, thet rate of return also increases. Equity shares have maximum risk so the maximum required rae, real is also highest. The risk return trade off means: that higher risk is associated with greater 1-4. °ty, ui : Prob, higher return and lower risk with a greater probability of smaller return. ‘This trade off which, a) faces between risk and return while consi 4 ering investment decisions is called the risk return ¢, For example, Rohan faces a risk return trade off while making his decision to invest. if hg ade all his money in a saving bank account, he will earn a low return i.e. the interest rate paid by ae Py but all his money will be insured up to an amount of €1 lakh (currently the Deposit Insurance ang, Guarantee Corporation in India provides insurance up to €1 lakh). However if he invests in equi faces the risk of losing a major part of his capital along with a chance to get a much higher retun a compared to a saving deposit in a bank the Generally speaking, itis assumed that when an investor wants [0 ear higher return, the ascume more risk, Now that you understand that risk is measured using volatility or standard devia ) the following chart should make sense. Risk-Return Trade-Off t High Risk Low Risk High Potential Return Low Potential Return g Return ‘Standard Deviation (Risk) Fig. 10.1 ‘This figure show the basic relationship between risk and reward. This risk return line shows that | higher the risk, more is the return. Investment decisions are based on the concept of risk return tradedf which implies “No risk No reward”. This implies that with increase in risk, the level of expected return rises. So the investor try to achieve a trade off between risk and return so that they achieve highest level of return with acceptable level of risk.Dividend ~Price change over the period ee : Total return = Price at the beginning of the year 3 Total Return _ F pte fA pa = 0.247 or 24.7% eater ofB ome) = 0.024 or 2.4% Fpalreturn of C ee = 0.077 or 7.7% jeamed the highest return. 2 MrRohan is thinking of acquiring some shares of ABC ltd. The rates of return expectations are as follows: Possible rate of return | 5% 0.20 10% 0.40 | 8% 0.10 11% 0.30 Computer the expected return on the investment | Expected Return =)” p, xr a Expected Return = (0.20) (0.05) + (0.40) (0.10) + (1.10) (0.08) + (0.30) (0.11) = 0.091 = 9.1%118 || Personal Finance and Planning 35 42 49 55 52 60 Find Return and Risk associated with the share of the company? Solution: : hare = Dividend received + Price change over the period Bence Price at the beginning of 2 jdend Per Share 1 5 2 a2 5 3 49 10 4 55 12 5 52 5 6 60, 12 Total Return = L ‘Average Return (R) = Te 2 34.36% Note: The return for the first could not be calculated as there was no data available for the precedin year. 8 Calculation of Risks: Deviation of Total Return | uare of Deviati from average Return % See cae (R-R) (R-R) 0.07 0.0049 | or 37.4544 237 5.6169 -12.54 157.2516 a 16.81Anal ‘Return and Risk yee) = 217.1378 sie-i) —— = 4342756 = 6.589% ecurities X and y under different situations are given below: ons : te give erm Probability | Security | Seeurly return associated with the securities an snd risk oO Barsecot7 ted Return calculation of Expect Probability (P;) 0.25 1S SrZo 04 18 ea 0.35, 22 77 18.65 eturn or Expected Return E(R) = 18.65% Calculation of Risk B, R, R.-ERD R=ERIP | PREP 0.25 15 -3.65 13.32 3.33 0.40 18 0.65 0.42 0.17 0.35 22 3.35, 11.22 3.93 24.96 7.43 Risk = \P {(R, -£(R,))P % ity Calculation of Expected Return Ee cow 0.25 7 0.40 2 0.35 24Solution: Return and Risk in case of security X aoa LR, ai 03 a0) 3 23 5.29 1587 04 R 48 -03 0.09 0.036 03 | 15 45 27 729 2.187 R, =2PR, = 123 Variance = 3.189) Risk = P(R, -R,)> = V3.180 = 1.95 Return and Risk in case of security Y e " = 7 | @@) | (R,-8,) | (R,-R,) 36 -1 1 52 0 0 0 42 1 1 03 R, = (13) Variance =06 _Risk (6,) = Gheficent of variation of y = Thought deviation the return of security Y is lower, still it seems to be better because its lower standard (2.24) as well as lower coefficient of variation (0.4), both suggest for it.100 with €100 as cor ~_ 100+ (1000-900) on 900 ; Interest + Price change over the period Ee) epee Aaun= rice at the beginning _ 100+(750-900) _ 50 900 900 8 If the expected return of equity share is 20.01% and the rate of inflation duri Calculate inflation adjusted return? Solution: Reeneeee ereceriene | Nominal Return 1+ Inflation Rate 140.2001 _ 1+0.08 Aa 1.2001 i 1.08 = 0.1112 x 100 1.12% ing the 9. Mr A is earning 20% interest on bonds and he is paying income tax atthe rate of 30% wha the effective rate of return on interest income. ' Solution: Rate of Interest (R) = 20% 0% Effective Rate (r) = Interest rate (1 - Tax rate) = 0.20 (1 - 0.30) = 0.20 0.7 .14 or 14% Income tax rateoo _ Analysis of Return and Risk VI 4 to earn 12% net return on his investment. 1 his income is subject te 30% rate of einterester te of return, eo ne Tax equivalent ra 10h 1g, FiO Ss: fective rate (F) = 2% io" BE = 30% wl ‘fax rate (I) = 30 (ye eee equivalent Pee a eerne 0.12 = = 0.1714 1-0.30 = 17.14% two options for investment. Option A offers 25% rate of interest whenever Option B offers yy Meas iM XS income is subject o income tax rate of 30% which one option i suitable for 0 t jnvestment? ae should go for the option providing higher net rate of return, Calculation of net rate of retuen Me jp both of the cases: ‘option A? Normal Rate of Return (R) = 25% Income tax Rate = 30% Effective rate of Return = ? Effective Rate = Rate of Return (I - Income tax Rate) = 0.25 (1 - 0.30) = 0.175 or 17.5% Option B: 18% tax free return so Mr. X should opt option B that provide higher rate of return in comparison to option A. 12, An investor is considering the following two investment proposals. The returns from both the proposals are same but their probabilities differ. Compute the Expected Return and Risk of the following two proposals and advise the investor. Return % Prob X Prob Y -10 0.05 0.20 15 0.15 0.20 20 0.30 0.25 2 0.25 0.25 30, 0.25 0.100.05 0.20 -05 22 O15 0.20 2.25 3 6.34 4 aa . 0.30 0.25 6 5 0.68 a | 0.25 0.25 6.25 6.25 3.06 a 0.25 0.10 25 3 18.06 am l 215 15.25 7175 oa 64 R = Expected Return = ZR, Pi Expected Return of proposal x = 21.5% Expected Return of Proposal y= 15.25% Risk= 32, (R,-R)” Risk of x= V77.75 = 8.81% Risk of y= V178.68 = 13.36% Investor should accept proposal X as it has higher return and lower risk then proposal Y. 43. You have recently graduated in finance and have been hired as a financial planner. Your bos, assigned you the task of investing @1 lakh for a cient who has a 1 year investment horizon, Youhay been asked to consider only the following investment alternatives: (i) Invest in fixed deposits @ 8.5% return. (ii) Invest in tax free bonds @ 8% return. (iii) Invest in equity share now @ €110 (year end price of @1 per share during the year Solution: In this question we can calculate pre tax return or post tax return. (i) Incase of Pre tax return Option (i) Interest in fixed deposit = 8.5% Option (ii) Tax free bonds ‘Tax free rate = 8% Pretaxrate= —°— = 11.42% (1-03) Option (iii) Equity = D, = %1; P, = 120; Py = 110 oliinepenedseturn= 21 (A=) Douefa) e 110 in case of tax free bonds we will choose tax free bonds, h nie re taking tax free returns en we at fixed ron teres deposit = 8.5% = 30% rate TA = 85 (1 - 0.30) = 5.95% =8% ponds apse? sep = 10% Ful aut 9-03) = 7% _euonishighest in case of tax free bonds, The second option is chosen. a spvestment options (j) invest in 10 year tax free bonds which provides annual interest oS var fixed deposit of bank at 10% p.a int isi ps in 10 ye: p.ainterest. Mr. X is in 30% tax bracket vee G ae is no surcharge Do you think Mr. X should invest in fixed deposit because it e ‘erest income? Show relevant calculations, et oe spear free REC bonds = 8.12% isexempt from Tax in ines en ipyearfixed deposit = 10% pa 230% Be a rate from fixed deposit = 10% (1 - 0.30) = 79% teare8 08> 7%, So Mr. X should opt for REC bonds, = Review Questions. Seine return? Explain the components of total return? Should unrealised capital gain (or less) to feincuded in the calculations of return? ‘llstate the computation of expected rate of return of an asset? ‘Dine Holding period return? How is it calculated? ‘Mssarsk? How can risk ofa single security be calculated? Explain with the help of example? *Watomsitutes return on a single asset? How is it calculated? ‘Diners. a Ttum trade off? Why risk return trade off is important while investing money? 5 Systematic and unsystematic risk? Give example of both? — aoa