RISK – RETURN ANALYSIS AND PORTFOLIO MANAGEMENT- LESSONS The traditional approach to portfolio management is based on a comprehensive financial

plan for the indresdual. If takes into are note the indiedual needs such as hosting , life insurance and Plan. The first are safely, tax need for current income, a counstant income that off set the effect of inflation, and time having on. Modern Portfolio the any (based monthly on the idea of market shape & Treyior) given mark attention to selecting the portfolio, rather than bonds. The stock are selected the lasion of need for income of appreciation But he selection is based on the risk and return analysis. The interest this to maximize the expected return and minimize the risk. The allocation process aims at meeting the requirements of the investor- the risk-seeker the risk and the risk averse. Finally, in managing the probation, the investor sometime assesses the risk and return of the secretes within the asset classes and changes them according the risk-return profited of the assets

I GROUPS / TYPES of INVESTORS & PORTFOLIO OF RISK 2. Risk-averse: these investor will select the investment only on the basis of risk attached to an investment and may ignore the return from the investment. 5. Risk-Seekers: those investors who are ready to take risk if the return is sufficient enough. 7. Risk. Neutrals: those investor who do not care much about the risk their investment decision are based on consideration often than risk and return. In general, all investors are risk-avere and only the degree of risk aversion differs

Expected Return K4 K3 K2 K1 K6 K5 rf

Risk-Gveese Risk-Neutral





The chart shars that ar risk increase from B1, to B2 the return also increases :• Proportionately from K1 to K2 for a risk-neutral investor; • More than Proportionately from k3 to k4 for a risk-avese investor & • Less than Proportionately from k5 to k6 for a risk-seeker investor. Since most of the investor in general are risk-avese, they require a most than proportional compesolion (as reflected by increased return) for a given increase in risk, therefore, K = rg + rp rf = Risk free rate rf = risk premium (II) The notir of Diversification: Investor seem to follow that well-known Adge:- “Do not keep allyour eggs in one basket”. They invariably interest In more than one security so that losses in one may be offset by gains in another, in this m investors are able to reduce the revialibly of return

(III) The Notor of Dominance. Modern Portfolio Management is based on two very basic and intuitively acceptable statements abont risk and return. • If two portfolios have identical exception returns, then investors would choose that Portfolio which has a lower risk • If two portfolios have identical risk then investors would chose that portfolios which has higher expected return. If a portfolio can yield a higher return with lower risk, it will dominate all other portfolios for investment.
(IV) The nohio of Non-Diversifiable or Market Risk Which diversified portfolio does not become risk-free. The most well diversified portfolio that one can think of is the one which contai all the scribes in the stock market (technocrat known as the market portfolio). Even this portfolio reveals variability as in evident from the fluchation in the market risk index this risk in clearly universe and is known as market risk.

In general, as the no. of securities in a portfolio increases, say up to 20 Or 25 the diversification reduces the portfolio risk rapidly. However, soon thereafter, the reduction to portfolio risk of any further diversification portfolio of alert 25 secretes selected from different Indnstris more or less represent a market portfolio. BSE sensex, consisting of securities only, in deemed to represent the entire market. But BSE. sensex and BSE-100 are actively very highly correlated. Clearly, increasing the no. of securities from to 100 does not necessary improve the diversification


Diversifiable t Risk None-diversifiable or Market Risk No. of Securities (say 20-25)

Reduction of Risk through Diversification

(V) The noton of Beta: the most important source of risk in the market risk because if cannot be eliminated divers fication, profatio them therefore, any were that the riskiness of a security shved be measured by is valnevali city to market risk if the market were to go down by 1% security go down by 0.5%, by 1% or by 2%? The secretariats of the secirly to the more mens of the market is known as the beta coefficients of the security. (VI) The noton of trade off before Risk and Return: The theory also demonsinates that if the security are correctly priced, the return on each securite unlod be somever rate with is risk as measured by its beta. The graplical deficle of thr resulting bivear relativ relation ship, called the cofilal market live, exists behaver riske and return of well-diversified profiteers

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