What is risk?. Risk Risk implies the extend to which any chosen action or an inaction that may lead to a loss or some unwanted outcome.

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RETURN, RISK, AND THE SECURITY MARKET LINE

Presentation transcript:

what is risk?

Risk Risk implies the extend to which any chosen action or an inaction that may lead to a loss or some unwanted outcome.

Risk Variability in return

SYSTEMATIC AND UNSYSTEMATIC RISK 4 Risk has two parts: 1.Non-diversifiable (systematic) 2.Diversifiable (unsystematic)

SYSTEMATIC & UNSYSTEMATIC RISK Systematic Risk is a risk that is associated with the entire market or economy. Eg. Can be change any inflation, interest rate risk, Market risk etc. Unsystematic Risk is a risk that is specific to an industry or a firm. Unsystematic risk is due to the influence of internal factors prevailing within an organization. Example can be company workers declare strike.

Systematic Risk 9 Systematic risk arises on account of the economy-wide uncertainties and the tendency of individual securities to move together with changes in the market. This part of risk cannot be reduced through diversification. It is also known as market risk. Investors are exposed to market risk even when they hold well-diversified portfolios of securities.

Examples of Systematic Risk 10

Unsystematic Risk 11 Unsystematic risk arises from the unique uncertainties of individual securities. It is also called unique risk. These uncertainties are diversifiable if a large numbers of securities are combined to form well-diversified portfolios.

Examples of Unsystematic Risk 12

Total Risk 13

Systematic and unsystematic risk and number of securities 14

Beta It is a measure of the sensitivity of the assets's returns to market returns, its non- diversifiable risk, its systematic risk, or market risk. or Beta (β) of a stock is a number describing the relation of its returns with those of the financial market as a whole

CALCULATION OF BETA or Beta =Covariance of Market and Individual Share / Market Variance

CALCULATION OF BETA Calculate Average Return on Market & Individual Share (Company’s Share) Calculate Deviations of Returns on Market & Individual Share Multiply Deviations of Market Returns & Deviations of Individual Share Returns. Take the sum and divide the sum by number of observations to get Covariance Calculate the Squared Deviations of Market Returns. Take sum and divide by the number of observations to get Variance of Market

….CONTINUED Divide the Covariance of Market and Individual Share by the Market Variance to get Beta EXAMPLE Beta\Beta Calculation for a Portfolio Step by Step.xls