Objective

Risk and Return Concepts: Concept of Risk, Types

of Risk- Systematic risk, Unsystematic risk, Calculation
of Risk and returns of individual security, Portfolio Risk
and Return
Risk
 Risk refers to the possibility that the actual outcome of an
investment will differ from its expected outcome.
 More specifically, most investors are concerned about the
actual outcome being less than the expected outcome.
 The wider the range of possible outcomes, the greater the
risk.
Types of risks
A. Systematic risk: it is caused by factors external to the particular
company and uncontrollable by the company. The systematic risk
affects the market as a whole. This indicates that the entire market is
moving in a particular direction either downward and upward. The
economic conditions, political situations and the sociological changes
affect the security market. The systematic risk is divided into:
a) Market risk: it is defined as that portion of total variability of return caused by
the alternating forces of bull and bear markets.
b) Interest rate risk: it is the variation in the single period rates of return caused
by the fluctuations in the market interest rate. It affects the price of bonds,
debentures and stocks. The fluctuations in the interest rate are caused by the
changes in the government monetary policy ad the changes that occur in the
interest rate of the treasury bills and the government bonds.
c) Purchasing power risk: variations in the returns are caused by the loss of
purchasing power of currency. Inflation is the reason behind the loss of
purchasing power. The rise in prices penalizes the returns to the investors and
every potential rise is a risk to the investor.
Factors affecting the systematic risk
 Economic factor
 Political and social conditions
 Forces of Bulls/Bears affect market risk
 Fluctuations in the market interest rate
 Government policies
B. Unsystematic risk: The factors are specific and unique
and related to particular firm. It stems from managerial
inefficiency, technological change in process, availability
of raw material, changes in consumer preferences and
labour problems. It can be classified into :
a) Business risk: it arises from inability of a firm to maintain
its competitive edge and the growth or stability of the
earnings.
b) Financial risk: it is associated with the capital structure of a
company. A company with no debt financing has no
financing risk. Higher the financial leverages, higher the
financial risk. It may also arises due to short term liquidity
problems, shortage in working capital due to funds tied in
working capital and receivables etc.
c) Default risk: These arise due to default in meeting the
financial obligations on time. Non-payment of financial
dues on time increases the insolvency and bankruptcy
costs.
Factors affecting Unsystematic risk
 Technological change
 Changes in consumer habits
 Non availability of raw materials
 Sales fluctuations, Lack of R&D
 Lockouts, high fixed cost
 Heavy debt/loans funds with high interest costs
affecting return on investment
Statistical Tools to Measure Risk
 Statistical tools such as measures of dispersion can be
used to evaluate the risk associated with returns from
the project or investment.
 Measures of deviation include variance and standard
deviation.
 Beta is the measure of non diversifiable risk. It
measures the sensitivity of the security with reference
to a broad market index like BSE, NIFTY.
Measurement of Expected Return & SD