Documente Academic
Documente Profesional
Documente Cultură
Ruchi Tyagi
Manjari Mishra
Suhrid Sarkar
Risk Apaar Sharma
Anmol Bajwa
Vikas Dubey
Ikwinder Dhawan
Aman Datta
Vishant Tyagi
What is Return?
Total return = Dividend + Capital gain
R ate of return = D ividend yield + C ap ital gain yield
D IV 1 P1 − P0 D IV 1 + ( P1 − P0 )
R1 = + =
P0 P0 P0
Example:
Hind manufacturing company data
Year Dividend
Per share
Closing
share
Calculate Rate of
Price
Return
2000 3.50 23.50
E(R)=Probability*Rate of Return
Portfolio
Combination of more than one security.
Year Return on Return on
stock stock
A(%) B(%)
2000 15 -5
2001 -5 15
2002 5 25
2003 35 5
2004 25 35
•Suppose we have stock A and stock B. The
returns on these stocks do not tend to move
together over time.
rate kA
of
return
rate kA
of
return
kB
time
rate kA
of
return kp
kB
time
Based only on your
expected return
calculations, which
stock would you
prefer?
Have you considered
RISK?
What is Risk?
Risk exists if there is something you
don’t want to happen – having a chance
to happen!!!
Company A Company B
0. 5
0.2
0.45 0.18
0. 4 0.16
0.35 0.14
0. 3
0.12
0.25
0.1
0. 2
0.08
0.15 0.06
0. 1
0.04
0.05
0.02
0
4 8 12 0
-10 -5 0 5 10 15 20 25 30
return return
Sources of risk
Business Risk
Financial Risk
Business Risk
That risk arising from the nature of the
business -- affects all producers.
Production or technical risk
Price or market risk
Casualty risk
Technological risk
Political, social, & individual risk f.
Personal risk
Financial Risk
Financial risk - variation brought about
by the way the business is financed.
e.g.,
the use of nonequity capital in the
business.
Financial risk might be measured as
the variation (e.g., Variance, Std. Dev,)
in the rate of return to equity.
Principle of Increasing Risk
As the relative amount of nonequity
capital used in the business increases,
financial risk increases at an increasing
rate.
Expected Risk and Preference
A risk-averse investor will choose among
investments with the equal rates of return,
the investment with lowest standard
deviation.
A risk-neutral investor does not consider
risk, and would always prefer investments
with higher returns.
A risk-seeking investor likes investments
with higher risk irrespective of the rates of
return.
Some risk can be diversified away
and some can not
portfolio
risk
Firm-
Firm-
specific
risk
Market risk
number of stocks
How do we Measure Risk?
2 0.20 -5 15 5
3 0.20 5 25 15
4 0.20 35 5 20
5 0.20 25 35 30
Expected Return
Stock A:
0.2(15%)+0.2(-5%)+ 0.2(5%)+ 0.2(35%)+0.2(25%)=15%
Stock B:
0.2(-5%)+0.2(15%)+0.2(25%)+0.2(5%)+ 0.2(35%)=15%
Portfolio:
0.2(5%)+0.2(5%)+0.2(15%)+0.2(20%)+ 0.2(30%)=15%
Standard Deviation
Stock A:
=0.2(15-15)^2+0.2(-5-15)^2+ 0.2(5-15)^2+ 0.2(35-
15)^2+0.2(25-15)^2=200
=sqrt(200)=14.14%
Stock B:
=0.2(-5-15)^2+0.2(15-15)^2+0.2(25-15)^2+0.2(5-15)^2+
0.2(35-15)^2=200
=sqrt(200)=14.14%
Portfolio:
=0.2(5-15)+0.2(5-15)+0.2(15-15)+0.2(20-15)+ 0.2(30-
15)=90
=sqrt(90)=9.49%
Compare the values
It’s
a measure of the sensitivity of a
security to market movements
Formula
Rjt = aj + bjRmt + ej
Beta,bj=Cov(Rjt,Rmt)/standard Deviation
Where,
Rjt : Return of security J in period t
aj : Intercept
bj :Regression Coeff. Beta
Rmt:Return on market Portfolio
ej :Random error Term
Calculating Beta
Return of security
. . . Beta =slope
Equation used: 15
Rjt = aj + bjRmt + ej . .
10 . . . .
. .
.. . .
.. . .
5
.. . .
-15 -10
.
-5 -5
. . 5
. 10 15
.. . . Market Return
. . . . -10
.. . .
. . . -15.
beta Values
beta = 1
Firmhas average market risk. The stock is no
more or less volatile than the market.
beta > 1
A firm is more volatile than the market
(ex: computer firms)
beta < 1
A firm is less volatile than the market
(ex: utilities).
How to reduce risk
Diversification
Investing in more than one security
to reduce risk.
Portfolio
Portfolio Risk-Return
Analysis(two asset case)
Portfolio return depends on proportion of wealth
invested in two asset.
Portfolio
return in no way is affected by corelation
between two asset.
Zero correlation:
• In zero correlation the returns of two asset are
independent of each other.
• The two asset can go for diversification and the benefit is
that it is without any cost.
• The investor can invest in high risk security and improve
their return by keeping the portfolio risk low.
Positive correlation:
• In reality returns of most asset have positive but less than
1.0 correlation.
• In this the correlation between risk and return is 0.5.
How to price risk?
Capital Asset Pricing Model(CAPM)
Arbitrage Pricing Theory (APT)
The CAPM equation:
Rj = krf + j (Rm - krf)
where:
Rj = the Required Return on security j,
krf = the risk-free rate of interest,
j = the beta of security j, and
Rm = the return on the market index.
CML v/s SML
CML represent the risk premiums of efficient portfolios
together.