SWARNAM S/UNIT 1/RISK & RETURN - CBS RISK AND RETURN SWARNAM S 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

INTRODUCTION-RISK & RETURN Individuals invest their money in different types of financial assets like government securities, bank deposits, debentures, preference shares and equity shares The primary objective in making these investments is to get benefits in future period The benefits are in form of interest, dividend and capital appreciation All securities do not yield the same return For example: Return on Government Securities is low, Equity Shares yield higher rate of return 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS RISK AND RETURN Risk -- Risk refers to the degree of variability of actual return from the expect return -- Greater the variability, Greater the risk -- Fewer the variability, Fewer the risk -- Example: An investor who has invested in government securities will definitely get the expected return -- However, if he invests in equity shares, the actual return may be greater or less than the expected return 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS Contd… For Example, Mr. A invested in the security X with the expectation of income of Rs.5,000. But he gets only Rs.3,000 on return. Though he is getting income of Rs.3,000 from the investment yet it is risky investment as actual return is less than expected return 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS Return is the motivating force, inspiring the investor in the form of rewards, for undertaking an investment The objective of any investor is to maximize expected returns from his investments Types of Return: -- Realized Return : ex-post -- Expected Return : This is the return that investors anticipate or expect to earn over some future period 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS Components of Return Current Return - Periodic Cash Inflow Capital Return - Price Appreciation or Depreciation 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS Example: Consider an initial investment in the stock of Reliance, Current selling price at a price of Rs.500 per share. An investor buys 100 shares making an initial investment of Rs.50,000. Assume that investment is made for one year, after which the investor would make an exit by selling the shares. Assume that Reliance declares a dividend of Rs.10 per share during one year. Further at the end of one year the share price is Rs.600 per share 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS Contd.. Total return = Dividend yield + Capital gain Total return =100*10+100*100= 1,000+10,000 Total return = 11,000 Total % Return = Dividend yield + Capital gain* 100 Initial Investment Total % Return = 22% 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS Rate of Return The return on security refers to the total gain or loss over a given period- say one year Rate of Return is calculated as a percentage of initial investment In Case of Debentures, the return consists of interest In Case of Equity Shares, the return consists of dividend and capital gains Variability of Return The degree of deviations The fluctuations are caused by volatile changes in the market Measurement of Return Standard Deviation Variance 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS CAUSES OF RISK Wrong Decision – What to invest in Wrong timing of investment Nature of Instruments Creditworthiness of Issuer : Government Securities are creditworthy than private sector Maturity Period Amount of Investment Nature of Industry or Business 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS TYPES OF RISK Unsystematic Risk Systematic Risk Market Risk Interest Rate Risk Purchasing Power Risk Business Risk Financial Risk Internal Risk External Risk 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS Systematic Risk -- Variability in a security’s returns associated with Market or Economy -- The investor cannot avoid this risk (uncontrollable) -- It is critical to all investors -- Effect of these factor is to put pressure on all securities in such a way that price of all securities move in same direction Example: -- The Government changes the interest rate policy -- Massive changes in tax rate 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS Contd… Unsystematic Risk (Unique Risk) – Specific to a Company -- Variability in security’s returns not related to overall market -- It is also called unique risk -- Risk arises due to factors specific to the company Example: -- The company workers declare strike -- R&D experts leaves the company -- The Company is unable to obtain adequate raw materials -- Loss of Big Contract -- Changes in consumer preference 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS SYSTEMATIC RISK Market Risk : Bull and Bear Market ; Tangible Events (earthquake, war, terrorist attack, fall in value of currency) and Intangible Events (overreaction to tangible events) Interest Rate Risk: If the interest rate moves up, the price of the bond declines and vice versa Inflation/Purchasing Power Risk - Fixed income securities, such as bonds subject investors to the greatest amount of purchasing power risk. The rise in price penalizes the return to the investor. The inflation may be demand pull or cost push inflation 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS UNSYSTEMATIC RISK Business Risk Internal Risk (Controllable) -- Fluctuations in sales -- Technological Problem -- Personnel Management – Strikes, Dishonesty of employees, Accidents or Death inside the factory -- Fixed Cost (during the period of recession or low demand -high risk) -- Single Product External Risk (beyond control) -- Natural Factors, Market Fluctuations, Regulatory Factors and Political Factors 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS Contd… Financial Risk -- Credit Risk (non-payment or delayed payment of interest or principal) -- Currency or Foreign Exchange Risk (variability in returns caused by currency fluctuations) -- Country Risk (When a country defaults on obligations) it affects all financial instruments ; economic instability and political instability -- Liquidity Risk – difficulty in selling , selling at discount rate -- Valuation Risk - if valuation is too high -- Business and Technology Risk (back pagers & typewriters ) -- Concentration Risk (invested in single asset is high risk) -- Information Risk (outsiders) -- Execution Risk (time gap between seeing & selling ) 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

RELATIONSHIP BETWEEN RISK AND RETURN The risk and return are directly variable Returns from securities are not certain or fixed Risk means possibility of losing some, even all of your original investment The total risk consists of two parts: systematic risk and unsystematic risk Market risk due to general factors it affects all the securities Unique risk due to the factors of the company. It can be reduced The risk is measured by Standard Deviation 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS

SWARNAM S/UNIT 1/RISK & RETURN - CBS PORTFOLIO INVESTMENT The investor should not hold all the eggs in one basket The investor should hold a well diversified portfolio Hence, it is advisable to invest in a number of securities 1/10/2018 SWARNAM S/UNIT 1/RISK & RETURN - CBS