Risk and Return

Risk and Return

Risk: Exposing to danger or hazard

Generally risk carries a lot of negative value with it because it refers to the danger involved in an investment but it is also said that higher the risk, more chances of getting higher returns. So therefore this can be said that risk is a mix of danger and opportunity. What proportion of danger and opportunity risk will carry depends on the analytical capability of the decision maker or the investor who is taking the risk.

In financial term risk is the probability of losing your investment or not getting the kind of returns you expected at the time of investment.

For example X makes an investment of Rs. 100 in stock market expecting his investment to grow to Rs. 150 in a time span of 1 year.

Types of risk:

1. Market risk: The risk which the entire market is exposed to. This risk is unavoidable for any kind of industry and has an impact on overall economic activities. This is also called Systematic Risk. War, recession in the economy is an example of market risk.

2. Unique risk: The risk caused by industry specific factors is called Unique or Unsystematic risk. This risk will cover threat the entire portfolio but a portion of it. For example a major fire lose in a company where you have invested is a unique risk because it will affect the shares of that company only.

Return: Return is the yield or increase in the investment over a period of time

For example X actually gets Rs. 150 after making an investment of Rs. 100 for a period of one year then the addition amount of Rs. 50 is his the return over his investment. Positive return can be considered as a reward for taking a risk.

Types of Returns:

1. Expected Return: The average of a probability distribution of possible returns.

2. Actual Return: As opposed to expected return, actual return is what investors actually receive from their investments. The discrepancy between actual and expected return is due to systematic and unsystematic risk.

Risk-Return Relationship

The phenomena of risk and return are applicable on virtually everything in this world. “If decisions are to lead to benefit maximization, it is necessary that individuals/institutions consider the combined influence on expected (future) return or benefit as well as on risk/cost. The requirement that expected