financial risk and return

2.  Expected Rate of Return : Rate of Return with
respect to future cash-flows
 How sure are your prediction ?
 It could take a wide range of values.
 Range, Band, Spectrum
 Rate of Return [k] needs to be qualified by its level of
certainty
 Can there be a measure for this certainty?

3.  The level of uncertainty with respected to an
expected outcome [ example: Rate of Return] is
called ‘Risk’ of that outcome.
 The description of an expected [future]
outcome has two elements:
 Its value
 Its risk
 What is the physical significance of ‘Risk’?

4.  A project is under planning. Ask 100 experts on
the expected outcome of the project.
 The average of the 100 values will be the expected
value
 The variance of the distribution of values will
represent its uncertainty or risk.
 Higher the uncertainty, higher is the risk
 What relevance is the risk for the investor?

5.  For a given Expected rate of return an Investor
would prefer the option that offers lower risk.
 There will be a trade-off between risk and
return.
 Each investor would have a limit of the risk he/she
is inclined to take
 Some investors are aggressive; they can take higher risk
and look for higher return. [Gambler]
 Some investors would prefer lower risk even if the
return is lower. [Safe Bet]
 In every investment opportunity it is desirable to
profile the risk along with the return

6.  Project categories based on risk profile
 A project [or an investment opportunity] with
moderate risk tends to have moderate return
 A project with significantly high return would
invariably have high risk
 An investment opportunity with normal risk-
return profile is called a project
 An investment opportunity with high risk-
return profile is called a ‘Venture’

7.  What is the risk profile of an infrastructure
project?
 Infra-projects are generally characterised by
 Large investment
 Long life of project
 Long implementation period
 Low return
 High risk
 Examples of Infra-projects

8.  Elements of Risk
 Business risk
 Technology risk
 Market risk
 Financial risk
 Industry risk
 Economy/market/Country risk

9.  How do you measure risk?
 Wherever possible variance [ σ2] is the measure of
risk
 Rating agencies have a system of assessing risk
profiles and indicating them on certain relative basis
[S&P, Moodys, CRISIL, ICRA etc.]
 Where do you use such measures?
 Wide usage of ratings in the financial market
 Investment decisions are guided by risks