) RISK AND RETURN — CONCEPTS AND ANALYSIS diver avs dierent moxives for investing. Leaving aside afew who lve the power and prestige of holding a major star Of minor share in a company, che majority ofthe investors have one of te following motives or 2 (a) Regular income either in the form of dividend or interest. (b) Capital gains or capital appreciation, () Hedge agains inflation, a positive real rate of return, (A) Safey of funds ant regularity of payment of interest and principal (6) Liquidity and marketability in the sense that investor can convert his investments into cash ols back again ico investments when cash ‘is not needed, Security Analysis involves an examination of expected return and accompanying risks. The fist three motives of ‘income, capital appreciation and a positive hedge agnnst inflation refer vo the expected rerum, The last two mouives of investor lead t0 the risks involved in the invest ents, These risks are due to uncertainty of returns, regularity of requmns, safety of funds, marketability oF lack of in ete Investors generally desire to have the maximum return possible, as they like returns, bur they dislike the risk, and the extent of rsk aversion varies from investor to investor. Bue the return depends on the extent of risk that the investor takes, The ren composes of arses retum (normally paid on a Tresury Bill ora bank deposit) plus a risk premium depending on the risk taken by the inves vestments are mad based on security abalyss and dcsions involved are what securities to be brought or sok and the extent or proportion of funds to be invested in exch, COMPONENTS OF RETURN Rerun is measured by taking the income pls the price change. Income is citer dividend or interest and price shange of the security is the capital gain or loss. The term yield i also used in respect of the fined income secuehe ‘Thus, we buy 2 12.5% Central Government bond for Rs. 95. The coupon rae is 125 per annum ae face vale ie Rs, 100 bur purchased for Rs. 95. Then the investor gets Rs. 12.5 by holding the bond for one yeat on a investment (of Rs. 95. Then the yiek (also called current yield) works out to 125/95 = 13.15%, ‘The expected return may differ from the realised rerum and the variation in return is again a risk element. ‘Thus, to generalise the return measurement as applicable 0 both variable dividend security and fixed income security, we have Income received + Pricechange Purchase price of asset, Total return = ‘This rerum shouk refer to a period of time, say a year and price change isthe difference between the pri the end and price atthe beginning of the period. The income may be negative or both can be positive and herein again les the risk clemen land price change can be both positive andB and Portfolio Managemen? Securities Analyst: Calculation of Average Returns Geon set jE 880 generally used methods of calculi *eomettic Average. The statistical compilation of each of Avichn the Avith ge rerurn namely ng he average rt chem is as fol tic Average is where x is the Arithmetic average Bx is the summation of returns over the given member of years, namely Geometric average is Gale RdeR) a+ Ry 1) R= tonal ewumn and Ry, Ry. R, are the returns for different periods 1s the number of periods ies of renurns together. 1596 or O.15 and the ceturn relative is 1 ¢ Re_ 1, iavested in the beginning. Thus, he Borh averages have their Own Uses anf Tes the n root of the product sesuling from multiplying 2 se Ris che retum and (1 + R) isthe retur elatve I the rerun 8 0.15 = 1.15 is the total return received at the end of the period from gcometric retum measures the compound cumlative reruns over ime: sigoificance ‘The measurement of return on any security is generally done on the bas level of the market exam, which bused on an approved indcs, suc av BSE. sete series (Of 30 sips), Base 1978-79 = 100, which is mon popularly wed tn Todi. The market recur isthe appreciation of che marker B.S. semsex number, reflecting te movements in price ofthe most widely taded 30 scrips on the B.S. over any period of time, As inthe USA, the Standard and Ror §00 Stock index is used 3s the daram line for comparing the returns of the marker with the individual reruns, in Indi investors tse the B.SE. snscx or the B.S. National Index of 100 scrips. The pce changes measure the apt appreciation ai! depreciation (gains or loses) and these changes have to be taken along with the dividend income on the secre to get the toal rears to compare the expected with the acral RISK ELEMENTS ~~ ‘The components of risk are broadly evo: 1. Sytematic Rik, which refers to that portion of the total variability of the return caused by common fictos affecting the prices of all securities alike through economic, political and social factors. 2. Ungrtematic Risk, which refers to that portion of the toal variability ofthe return caused due to unigue Fst, relating to that firm or industry, through such factors as management fale, labour strikes, raw material sarcty et Examples of Systematic Risk (2) Marker Ris — changes in market conditions (2) Interest Rate Risk — changes in imerest rats (G) Purchasing power or inflation risk (@) Trade cycles or Business conditions or Monsoons for agriculturally based economics like Tod Examples of Unsystematic Risk (1) Business Risk relating to the Industries. (2) Finan (3) Management Risk due to poor efficiency, faulty planning (4) Labour and other input risks of che company. Risk due to heavy interest burden or ineiient capital management,Pith and Renn — Compr and Anas x” While the systemic risk is common to all companies and has to be bore by the investor and compensated by the Risk Premium, the unsystemaic Risk cn be cod by the investor through proper diversification apd planing a proper investment strategy for the purpose. The former is uncontrollable while the later is contollahie by tke ‘company concemed and the investor Risk Concept Al investments are risky, whed in stock and capital market or banking and financial sector, real estat, bullion, ‘gold, et. The degree of risk however varies on the bass of the features of the assets, investment instrument, the mocks of investment, or the isuer of the security et. Even the so called risklss ascts like bank deposits carry some cost and time in realisation of proceeds of in conversion into cash Risk and Uncertainty Risk and uncertainty go together, Risk suggests that the decision-maker knows that there is some possible consequence of an investment decision, bur uncertainty involves a situation, where the outcome i not kaowh to th decision-maker. Bur basically, whether the outcome is known of not, the investments involve both risk and uncer. For our discusion, the word “Risk” is used to comprise all elements of variably. of reeum, uncertainty of the Some risks can be controled by the investors and some by the issuers of securities by planning. Others cannot be so controlled and they are to be borne compulsorily by the Investor What Causes the Risks? ‘These Risks are caused by the following factors (2) Wrong decision of what to invest in. (2) Wrong timing of investments (3) Nature ofthe instruments invested say, the category of assets like corporate shares or boss, Chit funds, Nidhi, Benefe funds ete, are bighly isy, as they ae in the unorganised sector. Some instruments as bank deposits oF P.O, Certificates are less risky, dae to their certainty of paymene of principal and interest (4) Creditworthines ofthe Ismer: ‘The securities of Government and semi-Gov than those ised by the corporate sector and much less secure are those i th bankers, shrofls chit funds, ete. P reument bodies are more creditworthy he unorganised sector like indigenous vate limited companies shares and shares of unlisted companies are more risky (5) Maturity Perit or the Length of besoment: The longer the period, the more risky i the investment normally. (6) Amount of nvesonent: ‘The higher the amount invested ia any six of investments in small quantities may be less risky. (7) Method of investment, namely, secured by collateral or not. (8) Terms of lending such as petioicty of servicing, redemption periods, etc (9) Nature of the industry or business in which the company y security the lager is the risk, while a judicious is operating. (10) National and international factors, ats of god, et. SYSTEMATIC AND UNSYSTEMATIC RISKS Reference was made to two types of Risk of investor: J. Systematic Risks are oot of exteroal an wnconteollabl factors, ising out of the market, nature ofthe industey and the state of the economy and a host of other Factors : 2. Ungstomatie Risks emerge out of the known and controllable factors, imernal to the ister of the sceuitics or companies. Examples of Systematic Risks @) Market Risk: This arises out of changes in Demand and Supply pressures in the markets, following the changing flow of information or expectations. The toralty of investor perception and subjective fctors influence the ‘events in the Markee which are unprediciable anc! give rise t0 tsk, whieh is noc controllableJ 0 nals and Perle Med re promised on i and ch Seria cn the inert Pe ockbrokens 2 ae ren eens 0 A ot det rl en i rn Oe hy ee es of interest from time 10 time. The ams of FN igh the cHAMESS Te credinwes ico The ren ya ne Sr) he imei gt depend on nature of instrument, sos, Bom OSD TT ich is wot CORUUPREE. Ss thro ae an cy sn SN dP a rune cw of prod cl, ET mag ice ea 8 ino gen ea ae ofr, tins Sn ting Pawel aati rl aN Demand pulser posh ition el yee im the nt a age EOE AT mand may BS Sy hg demat be fae’ Increase prices due to inadequate supplis and rising mens al iVeMENS een "expectation of furure interest rates and inflation or dive the defcis of the govemment, This cement of parc controll by bin Tia money supply oF ean OF CUrENCY power ki inert i Examples of Unsystematic Risks () Baines Rik see othe vi of Eon, ee This ba onthe mur seas rte pont mi pe opi, 06 oF COM Das ‘market conditions. They may be internal due 10 fall in production, ‘revenues and in profit of the compe” inate ac upp of easy ee, Me ne Buses ice in ss aa # the compa, ‘but can be corrected by certain changes in the company’s policies. i company, high levera sal ito Rt te meat of nino min NG al larger debt servicing problems or short-term liquidit rblems due to k hictuations in caring 2s rein cur hai Tac pols co ete rhe ye ies nan ‘eyme and dividends to shareholders. Sometimes, re conn runs we “ a ire oon cena erm, Pope ana ang and oe! fans sents cn be ue ‘correct this risk and as such it is controllable. Gi) Defeat or Inte be borower or issuer of certs may become insolvent or may defaul, od the pena dsc en nnn peep. Te boone’ Ted cing mihi ky suddenly and he became default prone aa in ix extreme frm i may kat insolvency or bankrupeces. Ia sich ca, the investor may get no fem or negative res. A invesunent in a healthy company’s share might tar out w be 4 waste paper, if within a shor span, bythe dciberate makes of Management or acs of God, che Company beeae sick andi share price rambled below is face vale Other Risks 1s adion ro the above major ris, bo in conrolable an unconolabe categorie, there re many moe, sshich can belted, but in sera pas, sy may vay in or, ea ce, Some of such identifiable rks are the Pla Rie, allowing the changes in the government, oF spy shown in fis or budgetary specs tc, though changin ta ar, imposition of convols or alain tepilaoos ete; Managonent Ray de co ero inelicencs of manigeocnt, casing losses the compa “Marra Ris inolvig lose of liu os fae in conversions fom one asset another 9, eh to bonds, of veer, Suh ks may ase dc eo sone fests of scutes, such as eal Or Eek fs find or Debeonie Redemption Reserv fund or epjment oppor de wo conversion tea, ached secur; which ay go advene tthe veto, All the above tyes of ks ae of varying dees, resting in ucerainy or variably of rerun fs fiat ate capital sc, ofereion of eye of tne snd wes ofthe men 1 formally the higher the risk en the higher isthe renun. But sometimes the risk is caused by Act of God and there may be no run a al PRECISE MEASURES OF RISK ‘Risk is measured by the variability of returns. ‘The assignment of probabilities and the calculation of expect values of rerum are methods of taking into aesoun the rk. Bx his metho does not pri he dcssonsmai a concrete value, indicative of the variability and therfore of rik. ins, ales, income, pro ety Which in eum g