Risk & Return Policy_Parakramesh Jaroli_MBA_FM

1. Presented By:
Parakramesh Jaroli
MBA (Dual) II - Semester

2. Risk & Return Relationship

3. Risk is the variability between the expected and actual
returns

4. TOTAL RISK
• The total variability in returns of a security
represents the total risk of that security.
Systematic risk and unsystematic risk are the
two components of total risk. Thus
• Total risk
• = Systematic risk + Unsystematic risk

5. Risks associated with investments
Systematic risk- Non diversifiable– The portion of the
variability of return of a
security that is caused by
external factors, is called
systematic risk.
– Market risk
– Cannot be eliminated
through diversification
– Due to factors affecting
all assets
-- Energy prices,
interest rates, inflation,
business cycles
Unsystematic -diversifiable
– When variability of returns
occurs because of such
specific factors--raw
material scarcity, Labour
strike, management
efficiency, it is known as
unsystematic risk.
– Specific to a firm
– Can be eliminated
through diversification
– Examples:
-- Safeway and a strike
-- Microsoft and antitrust
cases

6. Systematic Risks
1– 6
Risk due
to
inflation
Interest
rate risk
Political
risk
Market risk
Risk due to
govt.
policies
Natural
calamities
scams
monsoon
Industrial
growth
International
events
War like
situation

7. Non – Systematic Risks
Non
systematic
risks
Business
risks
Financial
risks
Risks due to
uncertainty
Disputes

8. • Unsystematic Risk
•
• Systematic Risk
• Number of security
• Figure 1: Reduction of Risk through Diversification
Risk

9. Risk Aversion
9
Risk Neutral
• Investors Seek the Highest Return Without
Regard to Risk
Risk Seeking
• Investors Have a Taste for Risk and Will
Take Risk Even If They Cannot Expect a
Reward for Doing So
Risk Averse
• Investors Do Not Like Risk and Must Be
Compensated For Taking It
Historical Returns on Financial Assets Are Consistent with a
Population of Risk-Averse Investors

10. Components of Return
 Yield
The most common form of return for investors is the
periodic cash flows (income) on the investment,
either interest from bonds or dividends
from stocks.
 Capital Gain
The appreciation (or depreciation)
in the price of the asset,
commonly called the
Capital Gain (Loss).
Return
Capital
Gain
Yield

11. Historical vs. Expected Returns
11
Decisions Must Be Based On Expected Returns
There Are Many Ways to Estimate Expected Returns
Assume That Expected Return Going Forward
Equals the Average Return in the Past
Simple Way to Estimate Expected Return

12. Risk and Return Fundamentals
12
Equity risk premium: the difference in equity
returns and returns on safe investments
• implies that stocks are riskier than bonds or bills
• trade-off always arises between expected risk
and expected return