Return

 The total gain or loss experienced on an investment over a given period of

time.
 The return on any stock traded in a financial market is composed of two
parts:-
a) Expected or normal return
b) Unexpected or uncertain return
 Expected returns:- The normal, or expected return from the stock is the part
of the return that investors predict or expect.
- This return depends on the information investors have about the stock, and
it is based on the market’s understanding today of the important factors that
will influence the stock in the coming year.
 Unexpected returns:- The unexpected, or uncertain, or risky part of the
return is the portion that comes from unexpected information revealed
during the year.
- It is the portion of an investment gain or loss that is attributable to
unforeseen events.
 Total return = Expected return + Unexpected return
R = E(R) + U

where, R stands for the actual total return in the year,

E(R) stands for the expected part of the return, and
U stands for the unexpected part of the return.

 The expected part reflects what had been anticipated and has already been
taken into account by investors when establishing values and is therefore
reflected in price of an asset.
 The unexpected part reflects surprises and influences actual returns by driving
unexpected return.
 The actual return tends to be different than the expected return, especially
over a short period because of unexpected surprises that occur during the
year.
 Unexpected news can be positive or negative, i.e, unexpected news can
affect share price in a negative or positive way depending on whether it
differs from expectations in a negative or positive way.
 But through time, the average value of U will be zero. This simply means
that on average, the actual return equals the expected return.
Positive news that is not as good as investors expected can cause a stock’s
price to move down, while negative news that is not as bad as investors
expected can cause a stock’s price to move up.
Announcement and News

 The release of information not previously available.

 At the beginning of the year, investors will have some ideas or forecast of
what the yearly GDP will be and how that may significantly impact the
profits of the firm.
 If the actual announcement of the GDP is the same as the forecast, then
the investors don’t really learn anything, and the announcement isn't news.
 There will be no impact on the stock price as a result. This is like receiving
redundant confirmation about something that you suspected all along; it
reveals nothing new.
 But if the government announcement of the actual GDP is different from
the forecast, then the investors learned something new and it can affect
the stock price of the competitor as well.

- This difference between actual result and the forecast is called the
innovation or the surprise.
 The impact of an announcement depends on how much of the
announcement represents new information.
 When the situation is not as bad as previously thought, what seems to
be bad news is actually good news.
 When the situation is not as good as previously thought, what seems to
be good news is actually bad news.

 Announcement = Expected part + Surprise

Risk

 Risk is the uncertain outcome or chance of an adverse outcome.

 The unanticipated part of the return, that portion resulting from surprises is
the true risk of any investment.
 Risk is not something we can eliminate completely. We can lower it,
mitigate it, and otherwise make sure it doesn't define our investments, but
there will always be some risk whenever we are seeking to obtain a
financial reward.
 In the stock market, all risk can be classified into one of two categories:
systematic or unsystematic.
Systematic risk

 Systematic risk refers to the hazard which is associated with the market or
market segment as a whole and that affects a large number of assets,
each to a greater or lesser degree.
 Systematic risk is due to the influence of external factors on an organization.
Such factors are normally uncontrollable from an organization's point of
view.
 Because systematic risks have market-wide effects, they are sometimes
called market risks.
 Systematic risks is caused by the fluctuations in macro-economic factors
like economic growth, government spending, money supply, changes in
interest rates, recessions, wars, inflation, etc. or changes in government
policy, the act of nature such as natural disaster, changes in the nation’s
economy, international economic components, etc.
 An individual company cannot control systematic risk. It affects the overall
market, not just a particular stock or industry.
 This type of risk is both unpredictable and impossible to completely avoid. It
is the risk that everyone assumes when investing in a market.
 Systematic risk can be partially mitigated by right asset allocation strategy.
Unsystematic risk

 Unsystematic risk refers to the risk associated with a particular security,

company or industry and that specifically affects a single asset or a small
group of assets.
 Unsystematic risk is due to the influence of internal factors prevailing within
an organization. Such factors are normally controllable from an
organization's point of view.
 Because these risks are unique to individual companies or assets, they are
sometimes called unique or asset-specific risks.
 Unsystematic risks usually arise from company-specific factors such as
product failure, rise in competition, production constraints, development of
substitute products, technological changes etc.
 This risk can be avoided by the organization if necessary actions are taken
in this regard.
 Proper diversification can nearly eliminate unsystematic risk by owing stocks
in different countries and in different companies.
 The important concept of unsystematic risk is that it is not correlated to
market risk and can be nearly eliminated by diversification.
 Actual return = Expected return + Surprise portion
R = E(R) + U
U has a systematic and an unsystematic portion.
R = E(R) + Systematic portion + Unsystematic portion
 As a general rule, investments with high risk tend
to have high returns and vice versa.