Thursday, 23 January 2020

Unit 4: Risk and Return


Unit 4: Risk and Return

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

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

As a consequence, the judgment factor still rules investment decisions.

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

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 on its source.

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

Beta is a comparative 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.

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

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

The investor can minimise his risk on the portfolio.

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

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

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

Bull-Bear Market Risk: This risk arises from the variability in the market returns resulting from alternating bull and bear market forces.

Country Risk: Country risk, also referred to as political risk, is an important risk for investors today.

Default Risk: It is that portion of an investment’s total risk that results from changes in the financial integrity of the investment.

Liquid Assets Risk: It is that portion of an asset’s total variability of return which results from price discounts given or sales concessions paid in order to sell the asset without delay.

Liquidity Risk: Liquidity risk is the risk associated with the particular secondary market in which a security trades.

Non-systematic Risk: The variability in a security’s total returns not related to overall market variability is called the non-systematic (non-market) risk.

Risk: Risk is associated with the variability of the rates of return from an investment.

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