Risk and return

For a single asset (share, debenture, real estate, farm, business, artworks, jewellery NB gambling is not
an investment vehicle)

Investment return (%) = holding period yield (HPY) / simple arithmetic return formula

Rt (%) = (P1-P0)/P0*100 + Div1/P0*100

Returns (%) = capital gains / losses + dividend yield

Where P1 = current period price MPS

P0 = previous period price MPS

NB

Dividend yield represents periodic income

Capital gains / losses represent the asset price appreciation or depreciation

Arithmetic return or HPY = (P1/P0) -1 = (P1-P0)/P0

Log returns = ln (P1/P0) used when normal data about returns is needed e.g in research using
parametric tests

It is important to measure asset performance in terms of returns i.e in terms of percentage or decimals
and not currency e.g stocks market price per share or indices e.g NSE index

NB portfolio (combination of assets can consist of stocks and indices hence the need for a common
measure also some stocks are cheap while others are expensive yet all may be part of a portfolio

HPY is applicable even in real estate and other investments i.e real estate and other investment are
likely to have capital gains element and periodic return element
Investment risk of a single asset

Variance = ∑(Ri – ER)^2 pi in case of uncertainty (futuristic data)

Variance = (∑(Ri – ER)^2) * 1/n in case of certainty (past or historical data)

Standard deviation = square root of variance

e.g 1

calculate the return and risk of asset X whose market price per share MPS and dividend per share DPS
as follows: NB year is 31st July

year MPS DPS

sh. Sh.

2015 46.35 2.3

2016 77.9 2.3

2017 62.5 1.0

2018 46.25 2.3

2019 62.5 2.6

2020 70 3.0

Rt (%) = (P1-P0)/P0*100 + Div1/P0*100

Returns (%) = capital gains / losses + dividend yield

Returns

2016 returns = ( 77.9-46.35)/46.35 + 2.3/46.35 = 0.681 + 0.05 = 0.73 = 73%

2017 returns = (62.5 – 77.9)/77.9 + 1/77.9 = -0.2 + 0.013 = -0.187 = -18.7%

2018 returns = (46.25 – 62.5)/62.5 + 2.3 / 62.5 = -0.26 + 0.037 = -0.223 = -22.3%

2019 returns = (62.5 – 46.25) / 46.25 + 2.6 /46.25 = 0.351 + 0.056 = 0.41 = 41%

2020 returns = (70 – 62.5)/62.5 + 3/62.5 = 0.12 + 0.048 = 0.168 = 16.8%

Mean or average returns of asset X = (73-18.7-22.3+41+16.8)/5 years = 89.8% / 5 years = 17.96%

NB the above returns are potential returns i.e the investor cannot realize cash unless they sell the
share or other asset

Risk

Investment risk of a single asset

Variance = ∑(Ri – ER)^2 pi in case of uncertainty (futuristic data)

Variance = (∑(Ri – ER)^2) * 1/n in case of certainty (past or historical data)

Standard deviation = square root of variance

Returns

2016 returns = 73%

2017 returns = -18.7%

2018 returns = -22.3%

2019 returns = 41%

2020 returns = 16.8%

Mean or average returns of asset X = 17.96%

Rt (%)
73
-18.7
-22.3
41
16.8
mean 17.96
40.3931
std dev 1

Futuristic data

e.g 2
calculate the return and risk of asset X whose market price per share MPS and dividend per share DPS
as follows: NB in year 2020 the MPS of asset X was sh.30 per share NB assume equal probabilities

year MPS DPS probabilities economic cycles

sh. Sh.

2021 46.35 2.3 0.2 boom

2021 77.9 2.3 0.2 recovery

2021 62.5 1.0 0.2 normal

2021 46.25 2.3 `0.2 recession

2021 65 2.6 0.2 depression

Rt (%) = (P1-P0)/P0*100 + Div1/P0*100

Returns (%) = capital gains / losses + dividend yield

Where

P1 = future period price MPS

P0 = current period price MPS

NB

Dividend yield represents periodic income

Capital gains / losses represent the asset price appreciation or depreciation

Economic cycle

boom returns = (46.35 -30)/30 + 2.3/30 = 0.545 + 0.0767 = 0.621 = 62.1%

recovery returns = (77.9 – 30)/30 + 1/30 = 1.596 + 0.033 = 1.63 = 163%

normal returns = (62.5 - 30)/30 + 2.3 / 30 = 1.083 + 0.0767 = 1.159 = 116%

recession returns = (46.25 – 30) / 30 + 2.6 /30 = 0.545 + 0.087 = 62.8%

depression returns = (65 - 30)/30 + 2.6/30 = 1.167 + 0.087 = 1.253 = 125.3%

average returns prob. Expected returns

boom returns = 62.1% 0.1 6.21%

recovery returns = 163% 0.3 48.9%

normal returns = 116% 0.2 23.2%

recession returns = 62.8% 0.2 12.56%

depression returns = 125.3% 0.2 25.06%

average or mean return = 115.93%

risk in terms of

variance and standard deviation

Investment risk of a single asset

Variance = ∑(Ri – ER)^2 pi in case of uncertainty (futuristic data)

Standard deviation = square root of variance

Scenario prob. Expected returns Deviation (Rt – Ert)^2*Pi

boom 0.1 6.21% 6.21 – 115.93 1203.85

recovery 0.3 48.9% 48.9 – 115.93 1347.91

normal 0.2 23.2% 23.2 – 115.93 1719.77

recession 0.2 12.56% 12.56 – 115.93 2137.07

depression 0.2 25.06% 25.06 – 115.93 1651.47

average or mean return = 115.93% variance 8060.07

standard deviation = √8060.07

standard deviation = 89.78%