170 Financial Management future cash flows should be examined in order to estimate the benefits resulting from the investment. To illustrate, suppose an investor buys 100 equity shares of a company for ¥ 1000 today and sells the share for 1,100 at the end of the year, he will get the return of 2 100 (i.e. @ 1,100 - @ 1,000) or 10%. But if the investor, at the end of the year is able to sell at 7 900, his return would be 100 or -10%. Since it is rarely desirable to invest the entire funds in a single asset or a security, he invest in a portfolio, a combination of assets/securites. Hence it is essential that every security be viewed in a portfolio context. Thus, it seems logical that the expected return of a portfolio should depend on the expected return of each of the security contained in the portfolio. It also seems logical that the amounts invested in each security should be important. Indeed, this is the case. The example of a portfolio with three securities shown in Table-1 A illustrates this point. The expected holding period value- relative for the portfolio is clearly: 23,000 20,000 giving an expected holding period return of 1 = 11.55 0%. Table-1 (B) combines the information in a somewhat different manner. The portfolio’s expected holding-period value-relative is simply a weighted average of the expected value-relative of its component securities, using current market values as weights, The procedure can be used as easily with holding-period returns. Table-1 (C) provides an illustration. Holding period return is simply 100 times the value obtained by subtracting one from the holding period value-relative. Thus a weighted average of the former will have the same characteristics as a weighted average of the latter. Since portfolio’s expected return isa weighted average of the expected returns of its securities, the contribution of each security to the portfolio’s expected returns depends on its expected returns and its proportionate share of the initial portfolio’s market value. Nothing else is relevant. It follows that an investor who simply wants the greatest possible expected return should hold one security: the one which is considered to have the greatest expected return. Very few investors do this, and very vew investment advisers would counsel such an extreme policy. Instead, investors should diversify, meaning that their portfolio should include more than one security. This is because diversification can reduce risk. RISK ‘The definition of risk includes the following meanings: "..possibility of loss or injury... the degree or probability of such loss.” This conforms to the connotation put on the term by most investors. Professionals often speak of “downside risk” and " upside potential.” The idea is straightforward enough risk has to do with bad outcomes; potential with good ones. As a formal measure of risk, such notions can be criticized on two grounds: vagueness and excessive simplicity. One might measure risk by the probability that