Tuesday, 7 January 2020

Unit 2: Risk and Return

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Unit 2: Risk and Return

Corporations are managed by people and therefore open to problems associated with their faulty judgments.

Corporations operate in a highly dynamic and competitive environment, and many operate both nationally and internationally.


As a result, the judgment factor still dominates investment decisions.

Risk can be defined as the probability that the expected return from the security will not materialize.

Every investment involves uncertainties that make future investment returns risk-prone.

Uncertainties could be due to the political, economic and industry factors.

Risk could be systematic in future, depending upon its source.

Systematic risk is for the market as a whole, while unsystematic risk is specific to an industry or the company individually.

The first three risk factors discussed below are systematic in nature and the rest are unsystematic.

Political risk could be categorised depending upon whether it affects the market as whole or just a particular industry.

Beta is a measure of the systematic risk of a security that cannot be avoided through diversification.

Beta is a relative measure of risk - the risk of an individual stock relative to the market portfolio of all stocks.

If the security's returns move more (less) than the market's returns as the latter changes, the security's returns have more (less) volatility (fluctuations in price) than those of the market.

It is important to note that beta measures a security's volatility, or fluctuations in price, relative to a benchmark, the market portfolio of all stocks.

The risk/return trade-off could easily be called the "ability-to-sleep-at-night test.

"While some people can handle the equivalent of financial skydiving without batting an eye, others are terrified to climb the financial ladder without a secure harness.

Deciding what amount of risk you can take while remaining comfortable with your investments is very important.

The investor can minimise his risk on the portfolio.

Risk avoidance and risk minimisation are the important objectives of portfolio management.

A portfolio contains different securities; by combining their weighted returns we can obtain the expected return of the portfolio.


Beta: A coefficient, that describes how the expected return of a stock or portfolio is correlated to the return of the financial market as a whole Portfolio: A collection of investments held by an institution or a private individual Systematic Risks: A risk of security that cannot be reduced through diversification.

Unsystematic Risks: Company or industry specific risk that is inherent in each investment.

The amount of unsystematic risk can be reduced through appropriate diversification  


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