Welcome to the lecture session

on
Return & Risk

Conducted By:

Dr. M. Kismatul Ahsan

Professor
Dept. of Finance
University of Dhaka
 Λ
Expected Return(K):
Λ
The expected rate of return (K) for
any asset is the weighted average
rate of return using probability of
each rate (actual) under each
circumstance as the weight.
 (Contd.)
If you invest in the security of any individual
firm (e.g., ‘A’ firm) then return of single asset:
^ n
So, KA =Σ[P1K1 + P2 K2 + P3K3+------- + PnKn]
t=1
^ n
KA= Σ KiPi Where,
i =1 Ki =Actual return of individual
asset under each event.
Pi = Prob. of happening actual
event.
Example: Calculation of Expected
Return of Single Asset
Event/Circumstance Ki Pi K iP i
Worst -10% .1 - 1%
Recovery 5% .2 1%
Average 10% .4 4%
Good 15% .2 3%
Boom 30% .1 3%
Σ KiPi = 10%
^
So, KA= 10%
 Expected Return on Portfolio:
Portfolio: If any investor invests in more than one
securities. Diversification of investment in different assets.

Objective: To minimize risk.

Λ n Λ

Kp = Σ WiKi Where,

i =1 W =Weight of individual asset in

total investment
n = No. of stocks in the port-
folio.
Example: If we invest 60 : 40 in assets A &
^
B respectively and the KB is 12% (assumed),
then,

^ ^ ^
KP = WAKA + WBKB
= .6 x .10 + .4 x .12
= .06 + .048
= .108 or, 10.8%
 RISK
What it is?
It’s a hazard or exposure to loss or injury.
So, it refers to the chance that some
unfavorable event might occur.

Investment Risk:
Uncertainty to the variability of return
associated with a given asset i.e., the prob-
ability of actual return less than the expected
return. The ↑ the chance of negative return,
the riskier is the investment and vice versa.
 RISK
(Contd.)
Concern: The degree of variability of return
or cash flows that might result from capital
investment. In an uncertain world, investors
cannot exactly or precisely tell what rate of
return an investment will yield. They can
quantify the rate of return by imposing prob.
distribution of the possible rate of return.
Investment risk is analyzed by attaching
probability to each possible rate of return.
So, wider the prob. distribution of return, the
riskier is the investment.
 RISK
(Contd.)

Share price in the market?

Depends upon risk and return. Investors,
by nature, are risk averse.
Measuring risk of single asset
^
∂i =√Σ Pi[ Ki – Ki ] (using standard deviation formula)
^ ^ ^ ^
Ki Ki [Ki –Ki] [Ki –Ki]² Pi Pi [Ki –Ki]²
-10 10 -20 400 .1 40
5 10 -5 25 .2 5
10 10 0 0 .4 0
15 10 5 25 .2 5
30 10 20 400 .1 40
Σ 90
Measuring risk of single asset
(Contd.)

∂i =√90 = +9.5
↑ the ∂, ↑ the risk and vice versa.

Ki + 1∂ =10 %+ 9.5% = 19.5% (when 1)

ᶺ
Ki - 1∂ = 10 - 9.5 = 0.5% (when r= -1 )
So, the range of variation is from
.5% -----19.5%
 Measuring risk of portfolio
(2 assets model)
∂p = √(w1 ∂1)² + (w2 ∂2)² + 2. w1 ∂1 . w2 ∂2. r1,2
Where,
w = weight of each asset in portfolio
r1,2 = Coefficient of correlations
between asset 1 & 2

i) If, r1,2 = +1, then, √ (w1 ∂1 + w2 ∂2)²

or, ∂p = w1 ∂1 + w2 ∂2
 Measuring risk of portfolio
(2 assets model) contd….

ii) If, r12 = -1, then, √ (w1 ∂1

- w2 ∂2)²
or, ∂p = w1 ∂1 - w2 ∂2