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Return
Return: Percentage form of earnings
from an investment or asset including
normal income and capital gain or loss
is called return. Return may be the
following three types:
1. Risk-free rate of return rate of
return can be earned by making
investment in government securities
of a country is known as risk-free rate
of return.
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Return
2. Nominal rate of return rate of
return
calculated
by
ignoring
existing level of inflation is known as
nominal rate of return.
3. Real rate of return - rate of return
determined by considering/adjusting
existing level of inflation is known as
real rate of return.
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Risk
Types of risk
i. Systematic risk risk that can not be avoided or minimized and
that is out of control of an individual or a business enterprise.
ii. Unsystematic risk - risk that can not be avoided but can be
minimized by making intellectual decision and that is to some
extent under the
control of an individual or a business
enterprise.
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Risk
iii. Business risk risk related to overall business activities
of a particular business enterprise that is mostly out of
control of that business enterprise.
iv. Financial risk - risk related to using of fund from debt
sources for forming and running business operations or
making investments by a particular party that is under
the control of that party.
Measures of risk
i. Standard Deviation absolute measurement of total risk
ii. Coefficient of Variation - relative measurement of total
risk
iii. Beta Coefficient - absolute measurement of systematic
risk
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Expected Return E ( R ) R
(R * P )
n
i
Risk
Risk
2
(
R
R
)
i
n 1
( P )( R R )
i
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Return (%)
Dev. (Ri-E(R))
Dev. Square
2004
20
49
2005
-8
64
2006
-5
-18
324
2007
15
2008
30
17
289
13%
730
Stand.Deviation2
730/(5-1)=
182.5
Stand.Deviation=
13.5%
Mean Return=
3-7
Weather
Rain
Moderate
Dry
Probability
(Pi)
0.25
0.5
0.25
Deviation
(Ri-E(R))
Deviation
Square
Dev sq* Pi
6.25
(25-13.25)
=11.75
(11.25)2
=138.0625
(138*.25)
=34.52
(14-13.25)
=0.75
(0.75)2
=0.5625
(.56*.5)
=0.28
(0-13.25)
=-13.25
(-13.25)2
=175.5625
(175*.25)
=43.89
E(R)=
13.25%
Stand
Dev2=
Risk=
8.87%
Stand Dev
78.69
8.87
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Coefficient of Variation
(CV)
A standardized measure of dispersion
about the expected value, that shows
the risk per unit of return. When, both
return and risk increase then coefficient
of variation (CV) should be used.
Std dev
CV
^
Mean
k
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Use of coefficient of
variance
m=1
j=1.9
Systematic Risk
(Beta)
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Comments on beta
Risk premium
The rate of return can be earned by making
investment in risk-free asset is called risk
free rate of return and the rate of return can
be earned by making investment in risky
asset is called nominal risky rate of return.
Generally the nominal risky rate of return is
higher that risk-free rate of return. The
increased required rate of return over riskfree rate of return is called risk premium.
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