Risk & Return

Return
(Income during the year + Ending price) / Initial price
Total risk of an investment
Standard deviation
Total risk = Unsystematic risk + Systematic risk
Risk & Return
Unsystematic risk
Also called Diversifiable risk, Company-specific risk, micro-level
risk
Can be diversified by adding various securities to the portfolio
Two types
Business risk
Financial risk
Systematic risk
Non-diversifiable risk / Economy-specific risk / macro-level risk
Can not be diversified
Systematic & Unsystematic Risk
Systematic risk can be calculated using beta
Beta = Covariance between market returns and security
returns / Variance of market returns
Covariance =
Beta tells about the riskiness not about the quantum of risk


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Systematic & Unsystematic Risk

Systematic risk = beta Standard deviation of market
Unsystematic risk = Total risk Systematic risk
Long-term investors look at total risk
Short-term investor look at systematic risk


Portfolio Theory
Dont put all your eggs in one basket
Portfolio theory
How to pick-up securities in your portfolio
Traditional portfolio theory and Modern portfolio theory
Modern portfolio theory
Proposed by Harry Markowitz
Provides a sound and definite methodology for investing
Uses SD and co-efficient of correlation for calculating portfolio risk
Degree of risk reduction depends upon the correlation among returns of
different investments (lower the correlation greater the risk reduction
potential when assets are combined to form a portfolio)


Portfolio Theory
Co-efficient of correlation




Returns of a portfolio
Risk of a portfolio


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