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Lecture 7 - Risk and Return

The document discusses the fundamental concepts of risk and return in finance, emphasizing their relationship and impact on investment decisions. It outlines various types of returns and risks, methods for measuring risk, and the importance of diversification in portfolio management. The content also highlights lessons from the 2008 financial crisis regarding excessive risk-taking.

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1 views

Lecture 7 - Risk and Return

The document discusses the fundamental concepts of risk and return in finance, emphasizing their relationship and impact on investment decisions. It outlines various types of returns and risks, methods for measuring risk, and the importance of diversification in portfolio management. The content also highlights lessons from the 2008 financial crisis regarding excessive risk-taking.

Uploaded by

OMNI GOD
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Risk and Return

Dr Ashish Saxena
Associate Prof.
SOB
Learning Outcome
After studying this, students will be able to:
Explain the fundamental concepts of risk and
return, including their relationship and impact
on investment decisions.
Opening Question
"If you had $10,000 to invest today, would
you put it all in a high-risk stock with the
potential for big gains, or a low-risk savings
account with guaranteed but small returns?
Why?"
Introduction
 Risk and return are fundamental principles
in finance.
 Investors seek returns on their investments,

but they must accept associated risks.


 Understanding this relationship is crucial for

investment decisions.
Concept of Return
 Return represents the gain or loss on an
investment.
 Expressed as a percentage of the initial

investment.
Formula:
 Total Return = [(P1 - P0) + D] / P0 × 100

Where:
 - P1 = Ending Price
 - P0 = Beginning Price
 - D = Dividends
Types of Return
 Actual Return: Return actually earned.
 Expected Return: Anticipated return.
 Required Return: Minimum return expected.
 Nominal Return: Before adjusting for

inflation.
 Real Return: Adjusted for inflation.
Concept of Risk
Risk is the possibility of losing some or all of
an investment.
 The uncertainty associated with returns.
Types of Risk
1. Systematic Risk (Market Risk) – Affects all
investments (e.g., interest rates, inflation,
politics).
2. Unsystematic Risk (Company-Specific Risk)
– Affects individual firms or industries (e.g.,
business risk, financial risk).
Measuring Risk
 Standard Deviation (σ): Measures total risk.
 Beta (β): Measures systematic risk relative

to the market.
 Variance: Measures deviation from the

mean return.
 Value at Risk (VaR): Estimates potential

loss.
Relationship Between Risk
and Return
 Higher risk leads to higher expected return.
 Risk-Return Tradeoff: Balancing risk and

potential return.
 Efficient Frontier: Optimal risk-return

combination.
Capital Asset Pricing Model
(CAPM)
Formula:
 E(R) = Rf + β (Rm - Rf)

Where:
 - E(R) = Expected return
 - Rf = Risk-free rate
 - Rm = Market return
 - β = Systematic risk factor
Diversification & Portfolio Management

 Diversification: Reducing unsystematic risk


by holding multiple assets.

 Efficient Portfolio: Maximizes return for a


given level of risk.
Activity-1:Caselet: The 2008 Financial Crisis

 The 2008 crisis was a result of excessive


risk-taking in mortgage-backed securities.
 Many financial institutions underestimated

risks and sought high returns.


 The collapse of Lehman Brothers led to a

global financial downturn.


 Lesson: Uncontrolled risk can lead to

massive financial losses.


Activity-2: Think-Pair-Share Activity

Imagine you are an investor considering two


investment options:
1. A high-risk stock with high return potential.
2. A low-risk government bond with stable but low
returns.

Think: Which investment would you choose and


why?
Pair: Discuss with a partner the trade-offs involved.
Share: Present your thoughts to the group and
justify your choice.
Scan to participate…….
Conclusion
 Riskand return are interrelated; higher
returns require higher risk.
 Investors must assess risk tolerance before

investing.
 Portfolio diversification can help manage

risk effectively.
Student Reflections
Thank You!

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