SENSITIVITY ANALYSIS SENSITIVITY ANALYSIS Sensitivity analysis is an approach for assessing risk that uses several possible return estimates to obtain a sense of variability among outcomes One of the tools used to perform this analysis is “RANGE”Range is calculated by subtracting the pessimistic (worst) outcome from the optimistic (best) outcome. Formula: RANGE = Maximum Value = Minimum Value ~ Example ~~ Suppose that you expect to receive the following returns on a particular asset. Economic Expected Situations Returns Deep recession 600 = Ea Mild recession 605 Normal 12 Minor Boom 626 Major Boom =|Standard Deviation * Standard deviation is a tool for assessing risk associated with a particular investment. * Standard deviation measures the dispersion or variability around a meanjexpected value: Formula: o = /EX2* P(X) —[E X*P(X)P eS ution Range = Max Value - Min Value = Rs.635 - Rs.600 = 35 rupees Higher the range, the more risky the asset is.S.D =, S.D Solution - (S.D for Stock A) x PO) x*Pa) | XP 13 0.25 3.25 42.25 15 0.50 7.50 112.50 7 0.25 425 72.25 EXe* P(X) 5)? = 1.41 rupeesSolution - (S.D for Stock B) Y PCY) yP(y) | Y?*P(Y) 7 025 175 1225 16 0.50 7.50 412.50 23 0.25 5.75 192.25 Total 1.00 15.00 257 ok yve*P(Y)-EYPMR 4 2 PF (15)? = 5.66 rupees Solution STOCK A STOCK B Expected Return 15 rupees 15 rupees StepriqserFegyttionnyp stodks] éPS86 that both S@RRARRRE the same expected returns. But the SD or risk is different. ‘The 8.0 of stock B > $.0 of stock A We can say that the return of stock Bis prone to higher fluctuation as compared to stock A(elie eo Clee) Sea kaa a * Ittells us the risk associated with each unit Cau mIN en n Saeed mT PAY Lt) Example BS de Eee eer Sea hur en CO Red cae’ Se oc eee Ey expected variation (S.D) of Rs. 5. Er LeeSolution STOCK A STOCK B Expected Value (Mean) 5 20 Standard Deviation 4 5 Formula Calculation cv OR ee ed reo Re eee ce + Since CV(A) > CV(B), so Stock A has more risk. ie een maa of PortfolioPORTFOLIO * Portfolio: A grouping of financial assets such as stocks, bonds, ete *A good portfolio consists of financial assets that are not strongly positively correlated DIVERSIFICATION Diversification is basically used as a tool to spread the risk across the number of assets or investments.A diversified portfolio should consist of securities that are not perfectly positively correlated. A portfolio should contain some high-risk and some low-risk securities Marae a ee ee ad RR i ea eet ee eae eR order to minimize the risk factor?For a company, a portfolio containing 20-25 Ere RCE cll oe EE MCT ec Re ad rue etal oe Rees ee ColeleSystematic itis PS url Sure latchd Seu a CE Reem Emo TCMCo Smeets ee esa CIC R NC ears Sos Risk