Risk and Return

Return
• Single period return
P
o = Rs.300, P1 = Rs.350
Return for the period is ………. %


P2 = 250


Return for the entire period ….?

Period-wise return ?
 Ex-post Returns
• Return = current income + capital
gains
• [(P2 – P1 ) + D2] / P1
 Expected Return
• Different scenario
• Chance / probability
• Return in case of each chance
 Chance return
 10% 30%
 23% 40%
 67% 25%
 Expected return ?
 Expected return from pf
E =E1W1 + E2 W2 + E3 W 3


E expected return
W proportion of money invested


 Return
Return : It is the primary motivating force that
drives investment.
§ It represents the reward for undertaking the
investment. In security analysis we are
primarily and particularly concerned with
returns from investors’ perspective.
§ The return of an investment consists of two
components : (i) Current return (ii) Capital
return.
1 Current return: Periodic cash flow (income)
such as dividend and interest. This can be
zero or positive.
2 Capital return: The price appreciation or
price changes. This can be zero, positive
and negative also.
Thus Total Return = Current return + Capital
return
 Risk
• Variability of security returns
• Standard deviation, variance
• SD is extent of deviation from the
average value of return = square
root of variance and variance is
the average of squares deviations
of observed returns from expected
value of returns
In this context of security analysis, we
interpret risk essentially in the terms of the
variability of the security return. The most
common measures of risk ness of security is
SD and Variance of return.
Given below returns of two stocks X and Y.

Period
 Return of stock X(%) Return of stockY(%)
 1 -6 4
 2 3 6
 3 10 11
 4 13 15
 5 16 19
Calculate which stock is more risky ?
Period X Y (X – X) (Y – Y) (X – X)2 (Y – Y)2
1 -6 4 -13.2 -7 174.24 49
2 3 6 -4.2 -5 17.64 25
3 10 11 2.8 0 7.84 0
4 13 15 5.8 4 33.64 16
5 16 19 8.8 8 77.44 64
Sum 36 55 310.84 154

Mean of X = 36/5 = 7.2 =X

Mean of Y = 55/5 =11=Y

Variance of X = ∑(X- X)2/(n -1)= 310.80/(5-1)= 77.7 and

the S.D =√77.7=8.815

 Economic Probability of Return from
scenario occurrence stock A(%)
Boom 0.25 36
Stagnation 0.50 26
Recession 0.25 12

The expected return would be E(R) =

(0.25*36)+(0.50*26)+(0.25*12) = 25%
The risk of the stock :

σ2 =∑P *[R – E(R)]2

i i
=(36-25)2 *0.25 + (26-25)2 * 0.50 + (12-25)2 *

0.25
 = 73%
SD = 8.54%
 Reduction of risk through
Diversification

Security Analysis: Measuring risk &

return.
Portfolio Mgt: minimize risk or maximize

return.
Example:

Concept of Covariance: the degree to

which the return of two securities vary

or change together.
Concept of Correlation: the degree of

relationship between two variables.

 Thanks