# Session - Risk and Return.pptx

Jun. 3, 2023
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### Session - Risk and Return.pptx

• 1. SECURITIES Types, Risk-Return Relationship and Measures
• 2. Securities - Types • STOCK – Common Stock – Preferred Stock (Cumulative & Redeemable) – Convertible Preferred Stock • LONG TERM DEBT – Debentures (Sinking Fund/Bullet Payment) – Convertible Subordinated Debentures – Secured Notes – Revolving Credit Notes – Euro-Currency Credit Notes • WARRANTS, OPTIONS AND FUTURES • MUTUAL FUNDS UNITS
• 3. Sources of Return-Risk • Return – Yield (Dividend cash flow or interest cash flow) – Capital Appreciation • Risk – Systematic Risk • Interest Rate Risk • Market Risk • Inflation Risk – Unsystematic Risk • Business Risk • Financial Risk • Liquidity Risk
• 4. Measuring Return • Holding Period Return or Yield HPR = {CF(t) + P(Closing) }/P(Beginning) HPY = HPR - 1 • Arithmetic Mean Return AMR = Sum of yearly return / No of years • Geometric Mean Return GMR = {[(1+R1) (1+R2)….(1+R n)] ^ (1/n)} - 1 • Arithmetic versus Geometric Mean Return • Realized Return versus Expected Return
• 5. Expected Return and Risk • Expected Return E (Ri) = ∑ Pi * Ri • Expected Risk Variance (σ2) = ∑ Pi * [Ri – E (Ri)] 2
• 6. Measuring Adjusted Return • Inflation Adjusted Return IAR = {(1+R)/(1+Inflation Rate)} - 1 • Dollar or International Return IR = {S end/S begin) x (\$ begin/\$ end)} - 1 S = Stock price at the end and begining \$ = Dollar required to buy Re. 1 or Rs. 100 • Market Adjusted Return MAR = NR - Market or Index Return during the period
• 7. Measuring Risk • Total Risk – Range, Standard Deviation, Variance of Return – Co-efficient of variation (SD/Mean) • Risk from specific source – Interest Rate Risk; Inflation Risk; Liquidity Risk; etc. • Systematic Risk • Unsystematic Risk • Risk Premium – Translate Risk into Expected Premium
• 8. Measuring Systematic Risk (Beta) • An investment in a single stock exposes the investor to all sources of risk the stock is exposed. • Impact of a stock on the risk of portfolio, which an investor holds, is considerably lower.
• 9. Beta, Required Rate of Return and SML • Risk of an individual security is measured by studying the relationship between the stock and market portfolio. • Beta, which is a relative measure, is equal to covariance between stock’s return and market portfolio’s return divided by variance of market portfolio’s return.
• 10. Beta Computation • Find weekly or monthly return {compounding return using ln(Pt/Pt-1)} for a stock and market portfolio (use a market index as a proxy) • Find covariance between the two returns(a) and variance of market portfolio’s return(b); beta = a/b • Alternatively, run a regression (keeping stock’s return as dependent variable and market portfolio’s return as independent variable) between the two; beta of the stock is equal to beta of the regression. • Test the reliability of beta
• 11. Beta of Sensex Stocks (96-2005)
• 12. Total Risk, Systematic Risk and Unsystematic Risk • Variance of returns measures total risk • Beta measures Systematic (common) risk • Unsystematic or unique risk is difference of total risk and systematic risk