Risk and Return Assignment help Assignment Help

Risk & Return Assignment Help

Risk and Return go hand in hand and are positively correlated. Higher the risk, higher is likely the gain. Risk reflects the chance that the actual return on an investment may be very different than the expected return. 

Sources of risk include:

Interest Rate Risk – variability of returns based on changes in level of interest rates

Market Risk – variability of returns due to fluctuations in the securities market

Inflation Risk – variability of returns due to reduction in purchasing power

Business Risk – risk of doing business in a particular environment

Financial Risk – risk arising due to companies resorting to financial leverage or debt.

Liquidity Risk – risk arising due to less number of trades for the security on the secondary market.

Total risk is measured by Variation. Variation of an asset is the sum of squared deviation of each possible rate of return from the expected rate of return multiplied by the probability that the rate of return occurs.

Var (K) = ⁿ∑_i=1 Pi (Ki – K’)²

Where Var (k) = Variability of returns

            Pi         = Probability of the ith possible outcome

            Ki        = Rate of return from ith possible outcome

            K’        = Expected rate of return

            n          = Number of years 

Risk can be diversifiable (also called Unsystematic risk) or non diversifiable (Also called Systematic risk). An investor can diversify his portfolio and thus reduce or eliminate the asset specific risk. On the other hand, non diversifiable risk is the market risk that cannot be reduced by diversification. This systematic risk is measured by Beta in the Capital Asset Pricing Model (CAPM).