2. Lecture Outline:
Risk Introduction
Elements of Risk
Measurement of Risk
Problems exercise
3. Risk Introduction:
The RISK can be defined in terms of variability
of return. “Risk is potential for variability in
return”.
The chance that an investment's
actual return will be different than expected.
Risk includes the possibility of losing some or
all of the original investment.
Difference between expected return and
realized return:
Expected Return: investor expect from his
investment.
Realized Return: return that investor actually
4. Elements of Risk:
The essence of risk in a investment is the
variation of return, variation is caused by numbers
of factors.
The element of risk is broadly classified into two
groups, first group comprises factors that are
external to a company and affect a large number
of securities simultaneously, called systematic
risk, and second group includes those factors
which are internal to companies and affect only
those particular companies, these factors can be
controllable, is called unsystematic risk.
Risk = Systematic Risk + Unsystematic Risk
Systematic Risk: counted as external factors,
uncontrollable in nature, affect high numbers of
securities.
5. Systematic Risk:
In the dynamic society, changes occur in the
economic, political and social systems constantly,
these changes have an influence on the
performance of companies and thereby on their
stock prices, “economical and political instability
adversely affects all industries and companies.
When an economy moves into recession,
corporate profits will shift downwards and stock
prices of most of companies may decline”. It also
include:
Interest Risk.
Market Risk.
Purchasing Power Risk.
6. Unsystematic Risk:
The return from a security may sometimes
vary because of certain factors affecting only
the company issuing such security. “raw
material usage, Labour Strike, Management
Influence”.
The unsystematic or unique risk affecting
specific securities arise from two sources: a)
the operating environment of the company, b)
the finance pattern adopted by the company,
some time referred as:
Business Risk
Financial Risk
7. Measurement of Risk
An intelligent investors tries to measure and
quantify the risk of each investment that he
considers before making the final selection.
Risk in investment is associated with return.
The return, in turn, depends on the cash
inflows to be received from the investment.
8. Example..
Suppose a share is currently selling at Rs,
120. an investor who is interested in the share
anticipates that the company will pay a
dividend of Rs. 5 in the next year. Moreover,
he expect to sell the share at Rs. 175 after one
year. The expected return from this investment
can be calculated as follows
R= Forecasted dividend + forecasted end of the period stock price - 1
Initial Investment
R= Rs. 5 + 175 - 1 = 0.5 0r 50 percent
Rs. 120
