RISK – RETURN ANALYSIS AND PORTFOLIO

MANAGEMENT- LESSONS
The traditional approach to portfolio management is based on a
comprehensive financial plan for the indresdual. If takes into are note
the indiedual needs such as hosting , life insurance and
Plan. The first are safely, tax need for
current income, a counstant income that off set the effect of inflation,
and time having on.
Modern Portfolio the any (based monthly on the idea of market shape
& Treyior) given mark attention to selecting the portfolio,
rather than bonds. The stock are selected
the lasion of need for income of appreciation But he selection is
based on the risk and return analysis. The interest this to maximize the
expected return and minimize the risk.
The allocation process aims at meeting the requirements of the
investor- the risk-seeker the risk and the risk averse.
Finally, in managing the probation, the investor sometime
assesses the risk and return of the secretes within the asset classes and
changes them according the risk-return profited of the assets
I GROUPS / TYPES of INVESTORS & PORTFOLIO OF RISK
2. Risk-averse: these investor will select the investment only on the
basis of risk attached to an investment and may ignore the return
from the investment.
5. Risk-Seekers: those investors who are ready to take risk if the return
is sufficient enough.
7. Risk. Neutrals: those investor who do not care much about the risk
their investment decision are based on consideration often than risk
and return.
In general, all investors are risk-avere and only the degree of risk
aversion differs
 Risk-Gveese
Expected
Return Risk-Neutral
K4

K3
K2 Risk-Seeker

K1
K6
K5

rf

B1 B2 Risk
The chart shars that ar risk increase from B1, to B2 the return also
increases :-
• Proportionately from K1 to K2 for a risk-neutral investor;
• More than Proportionately from k3 to k4 for a risk-avese
investor &
• Less than Proportionately from k5 to k6 for a risk-seeker investor.

Since most of the investor in general are risk-avese, they require a most
than proportional compesolion (as reflected by increased return) for a
given increase in risk, therefore,
K = rg + rp
rf = Risk free rate
rf = risk premium
(II) The notir of Diversification: Investor seem to follow that well-known
Adge:- “Do not keep allyour eggs in one basket”. They invariably interest
In more than one security so that losses in one may be offset by gains in
another, in this m investors are able to reduce the revialibly of
return
(III) The Notor of Dominance. Modern Portfolio Management is
based on two very basic and intuitively acceptable statements abont
risk and return.
• If two portfolios have identical exception returns, then investors
would choose that Portfolio which has a lower risk
• If two portfolios have identical risk then investors would chose that
portfolios which has higher expected return.
If a portfolio can yield a higher return with lower risk, it will dominate
all other portfolios for investment.

(IV) The nohio of Non-Diversifiable or Market Risk Which diversified

portfolio does not become risk-free. The most well diversified
portfolio that one can think of is the one which contai all the
scribes in the stock market (technocrat known as the market
portfolio). Even this portfolio reveals variability as
in evident from the fluchation in the market risk index this risk in
clearly universe and is known as market risk.
In general, as the no. of securities in a portfolio increases, say up to 20
Or 25 the diversification reduces the portfolio risk rapidly. However,
soon thereafter, the reduction to portfolio risk of any further
diversification portfolio of alert 25 secretes selected from different
Indnstris more or less represent a market portfolio. BSE sensex,
consisting of securities only, in deemed to represent the entire
market. But BSE. sensex and BSE-100 are actively very highly
correlated. Clearly, increasing the no. of securities from to 100 does
not necessary improve the diversification
Risk

Diversifiable t Risk
None-diversifiable or Market Risk
No. of Securities (say 20-25)
Reduction of Risk through Diversification
(V) The noton of Beta: the most important source of risk in the market
risk because if cannot be eliminated divers fication, profatio
them therefore, any were that the riskiness of a security shved be
measured by is valnevali city to market risk if the market were to
go down by 1% security go down by 0.5%, by 1%
or by 2%?
The secretariats of the secirly to the more mens of the market is
known as the beta coefficients of the security.

(VI) The noton of trade off before Risk and Return:

The theory also demonsinates that if the security are correctly priced,
the return on each securite unlod be somever rate with is risk as
measured by its beta. The graplical deficle of thr resulting bivear relativ
relation ship, called the cofilal market live, exists behaver riske and
return of well-diversified profiteers