Scribd
Upload
67 views

Risk and Return

Risk is a measure of uncertainty surrounding an investment's return. Investments with more uncertain returns are riskier. Return is the total gain or loss on an investment over a period. People have different risk preferences - risk-averse prefer less risk for a given return, risk-neutral base decisions solely on expected return, and risk-seeking prefer higher risk investments. Scenario analysis considers possible outcomes like worst, expected, and best to assess risk. Risk types are systematic from external factors and unsystematic from internal factors. Expected return is the average return calculated using possible returns and their probabilities. Standard deviation and coefficient of variation measure risk relative to expected return.

Uploaded by

জহিরুলইসলামশোভন
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
67 views

Risk and Return

Risk is a measure of uncertainty surrounding an investment's return. Investments with more uncertain returns are riskier. Return is the total gain or loss on an investment over a period. People have different risk preferences - risk-averse prefer less risk for a given return, risk-neutral base decisions solely on expected return, and risk-seeking prefer higher risk investments. Scenario analysis considers possible outcomes like worst, expected, and best to assess risk. Risk types are systematic from external factors and unsystematic from internal factors. Expected return is the average return calculated using possible returns and their probabilities. Standard deviation and coefficient of variation measure risk relative to expected return.

Uploaded by

জহিরুলইসলামশোভন
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 2

Risk and Return

Risk: Risk is a measure of the uncertainty surrounding the return that an investment will earn.
Investments whose returns are more uncertain are generally viewed as being riskier. More formally, the
term risk is used interchangeably with uncertainty to refer to the variability of returns associated with a
given asset.

Return: Return is the total gain or loss experienced on an investment over a given period.
Mathematically, an investment’s total return is the sum of any cash distributions plus the change in the
investment’s value, divided by the beginning-of-period value.

Risk preferences: Different people react to risk in different ways. Economists use three categories to
describe how investors respond to risk.

1. Risk-averse: A person who is a risk-averse investor prefers less risky over more risky
investments, holding the rate of return fixed. A risk-averse investor who believes that two
different investments have the same expected return will choose the investment whose returns
are more certain. Stated another way, when choosing between two investments, a risk-averse
investor will not make the riskier investment unless it offers a higher expected return to
compensate the investor for bearing the additional risk.
2. Risk neutral: An investor who is risk neutral chooses investments based solely on their expected
returns, disregarding the risks. When choosing between two investments, a risk-neutral investor
will always choose the investment with the higher expected return regardless of its risk.
3. Risk-seeking: Risk-seeking investor is one who prefers investments with higher risk and may
even sacrifice some expected return when choosing a riskier investment.

Scenario analysis: Scenario analysis uses several possible alternative outcomes to obtain a sense of the
variability of returns. One common method involves considering pessimistic (worst), most likely
(expected), and optimistic (best) outcomes and the returns associated with them for a given asset. In
this one measure of an investment’s risk is the range of possible outcomes. The range is found by
subtracting the return associated with the pessimistic outcome from the return associated with the
optimistic outcome. The greater the range, the more variability or risk, the asset is said to have.

Types of risk: In finance, different types of risk can be classified under two main groups:

1. Systematic risk: 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. It is a macro in
nature as it affects a large number of organizations operating under a similar stream or same
domain. It cannot be planned by the organization.
2. Unsystematic risk: 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. It is
a micro in nature as it affects only a particular organization. It can be planned, so that necessary
actions can be taken by the organization to mitigate the risk.

Expected return: The expected return is the average return that an investment is expected to produce
over time. For an investment that has j different possible returns, the expected return is calculated as
follows:
n
r =∑ (r j × Pr j )
j=1

Where r j = return for the j th outcome

Pr j = probability of occurrence of the j th outcome

n = number of outcomes considered


The standard deviation measures the dispersion of an investment’s return around the expected return.
In general, the higher the standard deviation, the greater the risk.

√∑
n
2
σ r= (r j −r ) × Pr j
j=1

The coefficient of variation is a measure of relative dispersion that is useful in comparing the risks of
assets with differing expected returns. A higher coefficient of variation means that an investment has
more volatility relative to its expected return. Because investors prefer higher returns and less risk,
intuitively one might expect investors to gravitate towards investments with a low coefficient of
variation.

σr
CV =
r

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy