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RISK AND RETURN

inspiring the investor in the form of rewards. • The importance of returns is : 1. Measurement of historical returns also helps in estimation of future returns. for undertaking the investment. It enables investors to compare alternative investments in terms of what they have to offer the investor. Measurement of historical (past) returns enables the investors to assess how well they have done. . 2.• Return is the motivating force. 3.

• Realized or Historical Return : This is ex-post return or return that was or could have been earned • Expected Return : This is the return from an asset that investors anticipate or expect to earn over some future period which is subject to uncertainty or risk and may or may not occur .

. dividends. etc • The appreciation ( depreciation) in the price of the asset is referred to as capital gain (loss) Yield : refers to the income derived from a security in relation to its purchase price.Components of Return • The periodic cash receipts or income on the investment in the form of interest.

.Measuring the Rate of Return • The total return is the income from the security in the from of cash flows and the difference in price of the security between the beginning and end of the holding period expressed as a percentage of the purchase price of the security at the beginning of the holding period.

k = Dt + (Pt – Pt-1) Pt-1 • K = rate of return • Pt = price of the security at time t i. at the end of the holding period • Pt-1 = price of the security at time t-1 i.e. at the beginning of the holding period or purchase price • Dt = Income or cash flows receivable from the security at time t .e.

the greater is the risk or greater the variability of return the greater is the variance. • The wider the probability distribution. • The more variable the possible outcomes that can occur the greater the risk. .RISK • Risk is defined as the chance that the actual outcome from an investment will differ from the expected outcome.

which affects all securities . • Market Risk : refers to the variability of returns due to fluctuations in the securities market • Inflation Risk : with rise in inflation there is reduction of purchasing power.Sources of Risk • Interest Rate Risk : is the variability in a security’s return resulting from changes in the level of interest rates. .

• Business Risk : refers to the risk of doing business in a particular industry or environment • Financial Risk : arises when companies resort to financial leverage or the use of debt financing • Liquidity Risk : is associated with the secondary market in which the particular security is traded .