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RISK-RETURN

RELATIONSHIP
RISK : Risk in an investment can arise out of several factor. It is
inherent in any investment. This risk may relate to loss or delay
in repayment of the principal capital or loss or non-payment of
interest or variability of returns. While some investments are
almost risk less like Govt. securities or bank deposits, others
are more risky.
RETURN: Return is defined as gain in the value of investment.
Return differs amongst different instruments. The most
important factor influencing return is risk. Normally, the higher

the risk ,the higher is the return.


Types of Risks
 Systematic Risks
 - Market risk
- Interest rate risk
- Currency risk
- Political risk
- Inflation risk
 Unsystematic Risks
 -Liquidity risk
 -Operational risk
 -Default risk

RISK RETURN RELATIONSHIP

Venture fund(highest
risk
risk))
Equity shares

convertible debentures / MFs

Non-convertible debentures
RETURN

PSU bonds

Lowest Risk (Bank deposits)

RISK
Low Risk vs. High Risk
Investments

4
Maximize returns,
minimize risks

5
Maximize returns, minimize
risks

6
Return
end - of - period wealth -- beginning - of - period wealth
Return =
beginning - of - period wealth

V0Initial value of investment

V1 Final value of investment

Return is V1 − V0
r=
V0

Or as a percentage r = V1 − V0 ×100
V0
Return
• Example 1
– An initial investment of $10,000 is made.
One year later, the value of the
investment has risen to $12,500. The
return on the
12500 investment is
− 10000
r= × 100 = 25%
• 10000
• Example 2
– An investment initially costs $5,000.
Three months later, the investment is
sold for 6000
$6,000.
− 5000The return on the
r=
investment ×100 =months
per three 20% is
5000

Risk-return trade-off in
different types of securities
 Various types of securities:
• Equity securities may be
 -Ordinary share or Common share, gives real
ownership because holder bears ultimate risk and
enjoy return and have voting rights
 -Preferential share, enjoy fixed dividend, avoids
risk, do not have voting right.
• Debt securities may be
 -Bond, a secured debt instrument, payable on first
on liquidity
 -Debenture, an unsecured debt instrument,
• Derivative securities are those that derive their
value in whole or in part by having a claim on some
underlying value. Options and
 futures are derivative securities
Return and Risk
• The greater the risk of a security, the
higher is expected return
• Return is the compensation that has to be
paid to induce investors to accept risk
• Success in investing is about balancing
risk and return to achieve an optimal
combination
• The risk always remains because of
unpredictable variability in the returns
on assets