Analysis of Risk & Return
- ‘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.
- 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.
- 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.
- 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.
- 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:
- This is often the fact return or the return that was or could have been earned.
Eg: Bank deposit
- 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:
- Periodic cash receipt (Interest or Dividend)
- 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.