Risk & Return-Analysis

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Analysis of Risk & Return

Introduction:

  • ‘Risk’ is common vocabulary and is widely used in the world of investment.
  • No investment decision can be analysed with out taking the ‘risk’ of alterations into account.

Eg:

  • 100/=, 9% 2015 Govt. of India Loan – Zero Risk – as repayment is absolutely assured.
  • 200/=, 12% 2005 TISCO Non Convertible Debenture – Risk of default in case of bad co. performance.
  • 10/= Colgate Equity Share (80% in 2001-02) – Risky investment.
  • Observations – the returns of the above three securities – 9%, 12%, 60% –
  • Higher the returns, higher will be the risk.

 

Measuring:

  • Probability of variation of expected income
  • Possibility of loss
  • A situation where the possible consequences of the decision that is to be taken are known.

Uncertainty:

  • Situation where probabilities can not be estimated.
  • The possible events and probabilities of their occurrence are not known
  • Hence risk and uncertainty are different from each other.

Return:

  • Is the realizable cash flow earned by its owner during a given period of time.
  • It is expressed as a percentage of the beginning of period value of the investment

Types of return:

  • Realized return

    • This is often the fact return or the return that was or could have been earned.

Eg: Bank deposit

  • Expected return:

    • Is the return from an asset that investors anticipate or expect to earn over some future period
    • The expected return is subject to uncertainty, or risk, or may or may not occur

Component of return:

  1. Periodic cash receipt (Interest or Dividend)
  2. Capital Gain/Loss

 

Probability and Rates of Return:

  • A probability is a number that describes the chance of an event taking place
  • Probabilities are governed by five rules and range from ‘0’ to ‘1’.
  • In a world of uncertainty, the expected return may not materialize.
  • In such a situation, the expected rate of return for any asset is the weighted average rate of return using the probability of each rate of return as the weight.