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Name of Institution
1
AMITY BUSINESS SCHOOL
Programme MBA(M&S) Semester II
COURSE FINANCIAL MANAGEMENT
Name of FacultyYOGESH MEHRA
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Name of Institution
RISK & RETURN
MBA ( M&S) 2012
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Name of Institution
Whatare investmentreturns? Investment returns measure the
financial results of an investment.
Returns may be historical orprospective (anticipated).
Returns can be expressed in:Currency terms.
Percentage terms.
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Name of Institution
What isthereturn on an investmentthat costs RE1,000and issold
after1 yearforRE1,100?
RE return:
Percentage return:
RE Received - RE Invested
RE1,100 - RE1,000
RE100.
RE Return/RE Invested
RE100/RE1,000 =0.10 =
10%.
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Name of Institution
What is investmentrisk?Typically, investment returns are not
known with certainty. Investment risk pertains to the
probability of earning a return lessthan that expected.
The greater the chance of a return farbelow the expected return, thegreater the risk.
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Name of Institution
Assumethe FollowingInvestment Alternatives
Economy Prob. T-Bill RIL TCS Am F. MP
Recession 0.10 8.0% -22.0% 28.0% 10.0% -13.0%
Below avg. 0.20 8.0 -2.0 14.7 -10.0 1.0
Average 0.40 8.0 20.0 0.0 7.0 15.0
Above avg. 0.20 8.0 35.0 -10.0 45.0 29.0
Boom 0.10 8.0 50.0 -20.0 30.0 43.0
1.00
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Name of Institution
Do thereturns ofRIL Inds.and Repo Men move with orcounterto theeconomy?
RIL Inds.moves withtheeconomy, so it ispositively correlated withtheeconomy. This isthetypical situation.
TCS moves counterto theeconomy. Suchnegative correlation isunusual.
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Name of Institution
Calculatetheexpected rate ofreturn on eachalternative.
. n
1=i
iiPr=r
r = expected rate of return.
rRIL= 0.10(-22%) + 0.20(-2%)
+ 0.40(20%) + 0.20(35%)
+ 0.10(50%) = 17.4%.
^
^
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Name of Institution
RIL has the highest rate of return.
Does that make it best?
r
RIL 17.4%
Market 15.0
Am. Foam 13.8T-bill 8.0
TCS 1.7
^
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Name of Institution
What isthestandard deviationofreturnsforeachalternative?
.
Variance
deviationtandard
1
2
2
!
!
!!
!
n
i
ii Prr
WW
W
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Name of Institution
WT-bills = 0.0%.WRIL = 20.0%.
W8 = 13.4%.WAm Foam= 18.8%.
WMarket= 15.3%.
.
1
2
!
!
n
i
iirrW
RIL Inds:
W = ((-22 - 17.4)20.10 + (-2 - 17.4)20.20+ (20 - 17.4)20.40 + (35 - 17.4)20.20
+ (50 - 17.4)20.10)1/2 = 20.0%.
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Name of Institution
Standard deviation measuresthestand-alonerisk ofan investment.
The largerthestandard deviation, the
highertheprobability that returns willbefarbelow theexpected return. Coefficient ofvariation isanalternativemeasure ofstand-alonerisk.
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Name of Institution
Expected Return versus RiskExpectedSecurity return Risk, W
RIL Inds. 17.4% 20.0%Market 15.0 15.3
Am. Foam 13.8 18.8
T
-bills 8.0 0.0TCS 1.7
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Name of InstitutionCoefficient ofVariation:CV = Standard deviation/expected return.
CVT-BILLS = 0.0%/8.0% = 0.0.
CVRIL Inds = 20.0%/17.4% = 1.1.
CVtcs = 13.4%/1.7% = 7.9.
CVAm. Foam = 18.8%/13.8% = 1.4.
CVM = 15.3%/15.0% = 1.0.
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Name of Institution
Stand-alone Market Diversifiable
Market risk is that part of a securitys
stand-alone risk that cannotbeeliminated by diversification.
Firm-specific, ordiversifiable, risk is
that part of a securitys stand-alone riskthat can be eliminated bydiversification.
risk risk =
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Name of Institution
The yearly price dataforasharescrip isasfollows
YEAR DIVIDEND (RS) CLOSING PRICE
2002 4.25 150
2003 5.50 256
2004 6 296
2005 6.75 354
2006 7.75 450
2007 9 375
2008 10.25 315
2009 11 395
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Name of Institution
--
VARIANCE=1/(n-1)*(Ri-R)^2
SUM OF EXP RETURNS=144.4 AVG RETURN 20.63
V=5431.03/6=905.17
SD=V=30.09%
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YEAR DIVIDEND
(RS)
CLOSING
PRICE
ER VARIANCE
2002 4.25 150
2003 5.50 256 74.33 2883.58
2004 6 296 17.97 7.11
2005 6.75 354 21.88 1.54
2006 7.75 450 29.31 75.23
2007 9 375 -14.67 1246.16
2008 10.25 315 -13.27 1149.28
2009 11 395 28.89 68.14
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Name of Institution
Good Average Poor
PROBABILITY 30% 50% 20%
RETURNS %
RIL 20 15 10
TCS 12 15 18
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Name of InstitutionEXPECTED ER AND RISKS RIL
CONDITIONS GOOD AVG POOR
EXPECTERRETURN
RETURN 20 15 10 15.5%
DEVIATION 4.50 -0.50 -5.50
PROB*DEVIA
TION
6.08 0.13 6.05
VARIANCE 12.25
SD 3.50%
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Name of InstitutionEXPECTED ER AND RISKS TCS
CONDITIONS GOOD AVG POOR
EXPECTERRETURN
RETURN 12 15 18 14.70%
DEVIATION -2.70 0.30 3.30
PROB*DEVIA
TION
2.19 0.05 2.18
VARIANCE 4.41
SD 2.10%
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Name of Institution
CONDITIONS ECONOMIC SCENARIO
GOOD AVG POOR EXPECTEDRETURN
RETURNS%
RIL 20 15 10 15.5%
TCS 12 15 18 14.70%
COVARIANCE
PROBABILITY 30% 50% 20%
DEVIATION RIL 4.5 -0.5 -5.5
DEVIATION TCS -2.7 0.30 3.30
PROB*PRODOFDEVIATIONS
-3.65 -0.08 -3.63
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Name of Institution
COV(R1R2)=SUMpi(R1-R1 BAR)(R2-R2 BAR)
COVARIANCE=-7.35
COEFF OF CORRELATION=COV(R1*R2)/SD 1*SD2=-1
BETA=COV(S,M)/^2M