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Risk & Return Analysis

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Abhishek Upadhaya
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20 views

Risk & Return Analysis

Uploaded by

Abhishek Upadhaya
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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1.

Risk & Return


In financial management, the risk is defined as the variability of expected returns from an
investment. For example, an investor makes a fixed deposit at an interest of 10% p.a. for a particular
period with a scheduled bank. There is virtually no risk attached with this investment since there is
no variability associated with the return. However, if the same amount is used to buy the equity
shares of a company, then the return in the form of dividends from this investment may vary from
one year to another. So, the investment in equity shares is risky as the returns are variable. The
more certain the returns from asset/investment, the less is the variability and therefore, less the
risk. It may be noted that the terms risk and uncertainty are usually used interchangeably. However,
the risk exists when the decision maker is able to estimate the probabilities associated with the
different outcomes. On the other hand, the uncertainty exists when the decision maker has no
historical data to develop the probabilities associated with the outcome.

Return associated with a decision is measured as the total gain or loss expected over a given period
of time by the decision maker. It may be defined as the return on the original investment made in
the particular asset/investment.

Every financial decision has two aspects i.e. the risk and the return. There is a risk involved in every
decision. The degree of risk, however, may differ from one decision to another. A riskless decision is
difficult to be visualized. Further, every decision has a return also. It may be emphasized that the risk
and return go together and there is always a conflict between the return from a decision and the risk
it brings into the firm.

A finance manager cannot avoid the risk altogether nor can he make a decision by considering the
return aspect only. Usually, as the return from an investment increases, its risk also increases. In an
attempt to increase the return, the finance manager will have to undertake greater degree of risk
also. Therefore, a finance manager is often required to trade off between the risk and return. At the
time of taking any financial decision, the finance manager has to optimize the risk and return. A
particular combination of risk and return where both are optimized may be known as Risk-Return
Trade off.

Questions
1) A company X ltd. Shows following possible returns

Possible Return
(%)
20
30
40
50
60
Calculate its expected return and risk.
2) Amit is planning to invest in Z ltd. The possible returns along with its probability of Z ltd. is given

Possible Return
(%) Probability
20 0.2
30 0.2
40 0.4
50 0.1
60 0.1
Calculate the expected return and risk.

2. Types of Risk
3. CAPM (Capital Asset Pricing Model)

Questions
1)

2)

3)

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