FINANCIAL

MARKETS &
SECURITIES
RISK & RETURN
 RETURN
2 • Return from an investment has two components – periodic income
and the capital gain.
• Total return = (Income + Price change)/Purchase price of the asset
• The return for a period can be calculated as an arithmetical average.

Average return = (Σ x)/n

• This can be misleading ( in case of a 100% return in Y1 and a 50%
drop in Y2 – reverting to the same level).
• Geometric mean is then calculated.

G = [(1+r1) (1+r2) ….. (1+rn)]1/n – 1

• This represents the compounded cumulative return over a time period

 RISK
3 • Risk in the traditional sense – any factor that may affect the
business.
• Variety of risks – business disruption (natural calamity), credit risk,
reputation risk, etc.
• Risk in investment – the possibility that the realized return would be
less than the expected return.
• Forces that impact the variations in return – risk elements
• Risk elements – could impact the market as a whole (the specific
country or all countries) or a particular asset class.
 SYSTEMATIC RISK
4 • Risk elements external to the firm – cannot be controlled. These
impact a large number of securities (or the market).
• These are called Systematic risk factors or uncontrollable risk
factors.
• Systematic risk factors – economic (global and domestic), political,
sociological factors.
 Market risk (investor reaction), interest rate, exchange rate,
inflation, etc.
• On an average half the risk can be attributed to systematic risk
factors
 UNSYSTEMATIC RISK
5 • Risk elements internal to the firm – can be controlled.
• These are called Unsystematic risk factors or controllable risk
factors.
• Unsystematic risk factors –
 Business risk caused due to operating conditions. Can be
controlled (efficiency in operations) and not controllable (raw
material price increase), but manageable
 Financial risk – mix of debt and equity.
• Total risk = Systematic risk + Unsystematic risk.
 MEASURING RISK
6 • Increase or decrease in the price of a security cannot be predicted
with certainty.
• Quantifying the risk that a given security will not realise its expected
return is critical for investment.
• Necessary for interpretation and comparison.
• Expected return, variance of the return and the standard deviation
are used to quantify risk.
• The variability of return around the expected (average) return is the
measurement of risk.
 DAILY RETURN HISTOGRAM – NIFTY FROM
7 1.4.2017 TO 31.12.2021
 DAILY RETURN HISTOGRAM – NIFTY
8
 DAILY RETURN HISTOGRAM – NIFTY FROM
9 1.4.2017 TO 13.12.2022
 STANDARD DEVIATION CHANGES
NIFTY OVER THE YEARS
10
Year σ (%)
2017-18 0.63
2018-19 0.78
2019-20 1.74
2020-21 1.42
2021-22 1.01
2022-23 1.10
2023-24 0.62
2024-25 0.65
Full period 1.17
 NIFTY OVER THE PERIOD
11

Particulars From 1.4.2017 till

31.3.2023
Daily return 0.0005
Daily standard deviation 0.012
Annualised return (250 days) 0.125
Annualised standard deviation 0.189
Probability of annual return > 6% 63%
Probability of annual return < 1% 27%
 VALUE AT RISK
12 • VaR is a very popular measure of risk measurement
• The amount of loss for a given time period for a certain confidence
level.
• VAR is calculated from historical returns, assuming normal
distribution (for a 99% confidence level)
2.33 × σ ×
where N is the number of days
• The interpretation is that one is 99% sure that the loss would not
exceed (μ – 2.33*σ*).
 NIFTY – MEASURING RISK
13

Parameter Nifty
Arithmetic mean of daily returns from 1.4.2021 0.00087

Standard deviation of daily returns from 1.4.2021 0.0084

VAR (99% confidence level for 10 days) (2.33 × σ × √10) 0.062

For a Rs. 10 lakh investment 61,892

Out of 186 days, the loss was never greater than the calculated loss as
above. The maximum daily loss was 3.5%
 BANKS RISK & RETURN
14 Bank Mean return (%) SD (%)
1.65
Axis Bank 0.059

ICICI Bank 0.142 1.67

HDFC Bank 0.012 1.32

KM Bank 0.016 1.63

SBI 0.176 1.78

Canara Bank 0.235 2.6

Nifty 0.079 0.873

Bank Nifty 0.066 1.26

 BANKS – RISK RETURN TRADE OFF
15

SBI Canara
ICICI
Bank Nifty
Nifty Axis
HDFC KM
 RISK RETURN TRADE OFF
16 Return E (r)

Preferred quadrant Risk taker

Risk σ

Risk averse investor Avoided quadrant

 BANKS – RISK RETURN TRADE OFF
17

Preferred quadrant
Risk taker

Risk averse Avoided quadrant