Understanding Risk and Return:

A return is an increase in the value of a project, investment, or item over time. This increase in value
can be expressed as a price increase or a percentage increase. A positive return shows a gain, while a
negative return indicates a loss.
For Example: With a help of financial data, I expect that the UBL expected return is 10%, but in real I
received 8% return.
So, in above case Actual return is 8% and Risk (of loss) is 2% (10% - 8% = 2%)
RETURN
Whether you're a seasoned investor or a curious novice, grasping the idea of return can provide vital
insights into the potential rewards of an investment, helping you make more informed decisions.
Return on a typical investment consists of two parts:
1. Yield
The periodic financial flows from the investment, such as interest or dividends, typically spring to
mind. For these payments, the issuer pays the asset's holder in cash.
2. Capital gain
This element is the increase (or decrease) in the asset's price, often known as the capital gain (loss). It
is the difference between the asset's purchase price and the price at which it can or is sold in case of a
long position.
In the case of a short position, it is the difference between the asset's sale price and the price at which
the short position is ultimately closed. A gain or a loss may happen in either scenario.
RISK
Risk is often associated with the dispersion, or the variability, in the outcomes. Risk is assumed to
arise out of variability, which is consistent with our definition of risk as the chance that the actual
outcome of an investment will differ from the expected outcome.
If an asset's return has no variability, it has no risk.
All investors are risk averse to an extent; everyone wants higher returns for every additional unit of
risk and tries to avoid unnecessary risk. There are two types of factors affecting risk:
External factors
They include social and economic factors. Some examples include economic policies, taxation,
political conditions, cultural changes, social changes, foreign effects, etc.
Internal factors
They influence the return of that specific security, which internal factors control. Some examples
include management, labour conditions, efficiency, governance, etc.
We have said that investors would like to maximize their returns. They will never choose to minimize
their risk. The reason is that there are costs like lowering an expected return to reducing risks.
With better understanding of risk and return of investment, you can evaluate and pick better option in
market. Furthermore, you can identify the risk and return then, based upon the obtained information
you can maximize the return and minimize the risk.
Relationship of Risk and Return:

There are a positive correlation means that a relationship between two

variables in which both move in the same direction. In between risk and
return with one important caveat. There is no guarantee that taking greater
risk results in a greater return. Rather, taking greater risk may result in the
loss of a larger amount of capital.
A more correct statement may be that
“There is a positive correlation between the amount of risk and
the potential for return”.
Generally, a lower risk investment has a lower potential for profit. A higher
risk investment has a higher potential for profit but also a potential for a
greater loss.
Risk-return matrices are vital tools in financial analysis that help evaluate and illustrate the
link between possible risks and rewards related to different investment possibilities. Below is
a summary of some frequently used risk-return matrices:

The set of ideal portfolios that provide the highest anticipated return for a given level of risk,
or the lowest risk for a given level of expected return, is represented by the Efficient Frontier
graph. It aids investors in determining the ideal ratio of risk to return.

Sharpe Ratio: This ratio calculates an investment portfolio's risk-adjusted return. It

determines the excess return, or return over the risk-free rate, for each standard deviation of
risk. Better risk-adjusted performance is indicated by a greater Sharpe ratio.

Treynor Ratio: The Treynor ratio calculates a portfolio's risk-adjusted return, much like the
Sharpe ratio does. But instead of calculating risk using standard deviation, it employs beta, or
systematic risk. It aids investors in evaluating an investment's performance in relation to its
systemic risk.

Sortino Ratio: The risk of losses below a particular threshold, such as the risk of losses
below the risk-free rate, is the only risk factor taken into account by the Sortino ratio, which
is a variation of the Sharpe ratio. It provides a more precise gauge of risk-adjusted
performance for assets with asymmetric risk profiles by concentrating on the volatility of
negative returns.

A straightforward visual depiction of the connection between risk and return for various
investments is the risk-return scatterplot. Every investment is shown on the graph with the
return on the y-axis and the appropriate risk (often beta or standard deviation) on the x-axis.
Investors may use it to see how different assets or portfolios compare in terms of risk and
return.

Risk Matrix: A risk matrix uses likelihood and impact to classify different types of hazards.
A scale is typically used to depict likelihood and effect, and a matrix is used to categorise
risks into low, moderate, high, and other risk categories. This matrix aids in risk prioritisation
and the selection of suitable risk management techniques.
Monte Carlo Simulation: While not a traditional risk-return matrix, Monte Carlo simulation
is a powerful technique used to model the uncertainty of investment outcomes by simulating
thousands of possible scenarios. It provides insights into the range of potential returns and the
likelihood of achieving certain investment goals under different market conditions.
Each of these matrices and tools serves a specific purpose in financial analysis, helping
investors make informed decisions based on their risk tolerance, investment objectives, and
market expectations.