Risk and Return

Risk and Return

Return refers the amount of total monetary benefits
a investors receive from a security.

( Pt  Pt 1 )  Div
Ri 
Pt 1
Where, Pt is price of security in time period t, Pt-1 is
price in last time period, Div is dividends.
 Return Calculation
Reliance Ind.
Time Opening Price Closing Price Div.
May-07 1752.0 1760.0 10.0

Return= {[(Pt-Pt-1)+Div ]/Pt-1}*100

{[(1760-1752)+10 ]/1752}*100 = 1.04%

 Risk

Variation in the mean rate of return exhibits

risk. Volatility in the stock market indicates
risk which affects the value of the stocks.
 Total Risk

Systematic Risk Unsystematic Risk

Market Risk Business Risk

Purchasing Power Risk Financial Risk

Interest Rate Risk

Forex Risk
 Systematic Risk
 Market Risk-Market risk refers to that portion of total variability in the
return caused by factors affecting the whole market. Economic,
political and sociological changes are sources of this type risk.

 Purchasing Power Risk- Purchasing risk is associated with inflation

and deflation. If an investor gets 5 percent rate of return and
prevailing inflation is 5.5 percent, it means that investor is realizing 0.5
percent loss on the investment over the period of time.

 Interest Rate Risk- Interest rate risk is associated with fluctuations in

rate of return caused by variation in general interest rate. Interest rate
risk is becoming prominent as not only domestic interest rate but also
interest rate prevailing in the international market can cause volatility
in the stock market.

 Foreign Exchange Risk-Foreign Exchange Risk is caused by changes

in foreign exchange rate.

 Market risk can not be diversified by enlarging the portfolio. This risk
affects the market as a whole and each stock seems to co-vary in the
same direction with the emergence of this risk.
 Unsystematic Risk
 Business Risk- Business risk, emerges because of operating
conditions, variability in business conditions, dividend
decisions etc.

 Financial Risk- The other type of non-market risk is financial

risk caused by the way a firm finances its activities or
expansion plans. If a firm raises debt in the market it
increases its obligation to pay fixed amount of fund, viz.,
interest to the debtors. Investors perceive it risky to invest in
those stocks whose debt equity ratio is high.

 Non-market risk is specific and associated with individual

stocks. This risk can be eliminated by enlarging and
diversifying the portfolio by holding different stocks of
different industries.
 Portfolio Return and Risk
N
Portfolio Return=
Rp  w R
i 1
i i

N
Portfolio Risk =  p   wi i
i 1

Portfolio Market Risk=

 p   wi  i
i 1
 Portfolio Return and Risk
Total Fund=1,00,000
SBI ABB TCS Wipro Infosys
Return 2% 3% 2% 5% 6%
Risk (Stdev) 2 4 3 2 3

Money Invested 10,000 20,000 25,000 25,000 20,000

Portfolio Return= 0.10*2 + 0.20*3 + 0.25*2 + 0.25*5 + 0.20*6

=3.75%

Portfolio Risk= 0.10*2 + 0.20*4 + 0.25*3 + 0.25*2 +0.20*3

= 2.85%