Risk: is the possibility of incurring loss in a transaction. Risk is inherent in any investment.

It ##Portfolio opportunity set

may relate to loss of capital, delay in repayment of capital, non-payment of interest, or The expected return/standard deviation pairs of all portfolios that can be constructed from
variability of returns. Risk and return of an investment are related. Normally, higher the risk, a given set of assets.Given a set of assets, the total number of portfolios that can be
higher is the expected return. constructed at different levels of risk and expected returns. The portfolio opportunity set
The expected return is uncertain future return that an investor expects to get from his helps an investor construct a portfolio with the assets he/she has at his/her risk tolerance.
investment. ##Efficient portfolio: is a portfolio which dominates other portfolios in a set of feasible
The realized return is the certain return that an investor has actually obtained from his portfolios. A portfolio is said to dominate another portfolio if it has either a lower standard
investment at the end of holding period. deviation and the same expected return, or a higher expected return in the same standard
##elements of risk deviation as the other portfolio. An investor will be interested only in the efficient portfolios
Systematic risk is that portion of total variability in security returns caused by factors that in a set of feasible portfolios. '
We external to the company and affect a large number of securities simultaneously. Changes ##Efficient frontier: is the graphical representation of all the efficient portfolios in a set of
in economic, political and social systems of the country influence the performance of several feasible portfolios. When the expected return and the standard deviation of all portfolios
companies, leading to variability in returns of these companies. considered for investment are plotted on an XY graph, a dark shaded area will emerge in the
Systematic risk is further subdivided into interest rate risk, market risk, and purchasing graph representing all the portfolios. The portfolios lying in the north west boundary of the
power risk. shaded area are more efficient than all the portfolios in the interior of the shaded area. This
1. Interest rate risk is a type of systematic risk that particularly affects debt securities like boundary of the shaded area containing all the efficient portfolios in the set is known as the
bonds and debentures. A bond or debenture normally has a fixed coupon rate of interest. efficient frontier. It will be a concave curve.
The issuing company pays interest to the bond holder at this coupon rate. Portfolio: is a group of securities held together as an investment. The process of creating a
2. Market risk- Market risk is a type of systematic risk that affects shares. Market prices of portfolio is called diversification. It is an attempt to spread and minimize the risk in
shares move up or down consistently for some time periods. A general rise in share prices is investment by allocating investment funds over several securities with different risk-retum
referred to as a bullish trend, whereas a general fall m share price is referred to as a bearish characteristics.
trend. ##Portfolio analysis: is the initial phase of portfolio management process. It consists of
3. Purchasing power risk- Another type of systematic risk IS the Purchasing power risk. It identifying the range of possible portfolios that can be constituted from a given set of
refers to the variation in investor returns Caused by inflation. securities and calculating the return and risk of each such portfolio' for further analysis.
Unsystematic risk is the variability in security returns caused by internal factors affecting ##ASSUMPTION OF CAPM
only the performance of the company issuing the securities. This risk is also known as unique The assumptions are listed below:
risk because it affects only specific companies or industries. 1. Investors make their investment decisions on the basis on risk-return assessments
The two types of unsystematic risk are inferred to as business risk and financial risk measured in terms of expected returns and standard deviation of returns.
respectively. 2. The purchase or sale of a security can be undertaken in infinitely divisible units.
Business Risk- Every company operates within a particular operating environment. This 3 Purchases and sales by a single investor cannot affect prices.
operating environment comprises both internal environment within the firm and external 4.. There are no transaction costs. Given the fact that transaction costs are small, they are
environment outside the firm. The impact of these operating conditions is reflected in the probably of minor importance in investment decision-making, and hence they are ignored.
operating costs of the company. The operating costs can be segregated into fixed costs and 5. There are no personal income taxes. Alternatively, the tax rates, on dividend income and
variable costs. capital gains are the same, thereby making the investor indifferent o the form in which the
Financial Risk- Financial risk is a function of financial leverage which is the use of debt in the return on the investment is received (dividends or ' capital gains).
capital structure. The presence of debt in the capital structure creates fixed payments in the 6. The investor can lend or borrow any amount of funds desired at a rate of interest equal to
form of interest which is a compulsory payment to be made whether the company makes the rate for riskless securities.
profit or loss. This fixed interest payment creates more variability in the earnings per share. 7. The investor can sell short any amount of any shares
What is 'Market' 8. Investors share homogeneity of expectations. This implies that investors have identical
A market is a medium that allows buyers and sellers of a specific good or service to interact expectations with regard to the decision period and decision inputs.
in order to facilitate an exchange. Market can also refer to the general market where ##SML (Security Market Line): is a straight line which expresses the relationship between the
securities are traded. This form of the term may also refer to specific securities markets and expected return and the systematic risk (measured by beta) of a security or portfolio. For the
may take place in person or online. The term "market" can also refer to people with the Well diversified portfolio, the unsystematic risk tends to become zero and the only relevant
desire and ability to buy a specific product or service. risk is the systematic risk. Hence, the expected return of a security or portfolio should be
##Primary market: is the market in which new issues of securities are sold by the issuing related to the systematic risk as measured by beta. This relationship can be determined
companies directly to the investors It is also called New Issues Market (NIM). When a new graphically.
company is floated, its securities are issued to the public as an Initial Public Offer (IPO). ##CML (Capital Market Line): is the straight line which expresses the relationship between
When an existing company decides to expand its activities by lssuing additional securities, the return and risk of all efficient portfolios. The appropriate measure of risk for an efficient
these are issued in the primary market as a Follow on Public Offer (FPO). It does not have a portfolio is assumed to be the standard deviation of return of the portfolio. There is a linear '
physical structure or form; all the agencies which provide the facilities and participate in the relationship between risk as measured by the standard deviation and the expected return
process of selling securities to the investors constitute the Primary market. for these efficient portfolios. This relations is graphically represented by the Capital Market
##Secondary market: is the market in which securities already issued by companies and Line.
owned by investors are subsequently traded among investors. It is contrasted with the '
Primary market where securities are issued or sold by the company to an initial set of
investors. The buying and selling of these securities then take place in the secondary market.
##Key Differences between Primary Market and Secondary Market
The securities are formerly issued in a market known as Primary Market, which is then listed
on a recognized stock exchange for trading, which is known as a secondary market.
The prices in the primary market are fixed while the prices vary in the secondary market
depending upon the demand and supply of the securities traded.
Primary market provides financing to new companies and also to old companies for their
expansion and diversification. On the contrary, secondary market does not provide financing
to companies, as they are not involved in the transaction.
At the primary market, the investor can purchase shares directly from the company. Unlike
Secondary Market, when investors buy and sell the stocks and bonds among themselves.
Investment bankers do the selling of securities in case of Primary Market. Conversely,
brokers act as intermediaries while trading is done in the secondary market.
In the primary market, security can be sold only once, whereas it can be done an infinite
number of times in case of a secondary market.
The amount received from the securities are income of the company, but same is the income
of investors when it is the case of a secondary market.
The primary market is rooted in a particular place and has no geographical presence, as it
has no organisational setup. Conversely, the Secondary market is present physically, as stock
exchnage, which is situated in a particular geographical area.
##The characteristics of a well-functioning securities market are:
Efficient - Internal - Markets must be efficient internally.
Efficient - External - Markets react quickly to new news; existing prices reflect all available
information.
Liquidity - Markets are liquid and as such, assets can be bought or sold easily. There are
numerous buyers and sellers giving depth to the market.
Continuity - In the context of liquidity, prices do not change substantially from one
transaction to another unless significant new news arises.
Marketability - In the context of liquidity, marketability is the ability to sell an asset quickly.
Timely and accurate information - New information is brought to the market in a timely and
accurate way.
Stock exchanges facilitate the secondary market transactions.
Types of order-
1. Market order: is the order placed by the investor to buy or sell a stated number of
securities immediately at the best prevailing price in the market. In the case of a buy order,
the best price id the lowest price obtainable in the case of a sell order, the best price is the
highest price obtainable.
2. Limit order: is an order in which the investor specifies the price at which he wants the
transaction to be executed. In the case of a limit order to buy; the investor specifies the
maximum price or ceiling price that he will pay for the security. In the case of a limit order to
sell, the investor specifies the minimum price or floor price he will accept for the sale
transaction.
3. Short sale: is a speculative activity engaged in by speculators who anticipate a decline in
security prides in the near future. Here, the speculate agrees to sell the security at the
current market price with the intentign of buying it at a lower price when the price declines
as anticipated so as to deliver the security sold at the time of settlement of the trade.
4. Stop order: is a market order'in which the investor specifies a stop price to limit the loss
that may arise from adverse movement in the market price of the security. In a sell order,
the step price will be below the prevailing market price; if the market price moves down and
reaches the stop price, the sell order will be executed at the best available price to prevent
further loss. In a buy order, the stop price will be above the prevailing market price. Its also
known as stop loss order.