Amity Business School

1
Amity Business School
MBA Class of 2015, Semester II
ACCOUNTING & FINANCIAL MANAGEMENT II
Module II (Risk and Return)

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Risk and Return
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Risk
Risk refers to the possibility that the actual
outcome of an investment will differ from its
expected outcome.






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Total Risk = Unique Risk + Market Risk
TYPE OF RISK
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Unique Risk:- part of total Risk which stems
from firm-specific factors. Also known as
Diversifiable Risk or Unsystematic Risk

Market Risk:- part of total Risk which is
attributable to economy-wise factors. Also
known as Non-Diversifiable Risk or
Systematic Risk


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Return
Return is the actual income received plus change in
market price of an asset/investment


Total Return = Current Return + Capital Return
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Return on A Single Asset

price) security eginning (opening/b 1 - t period, time at price security P
price) security nding (closing/e t period, time at price security P
t period, time of end the at dividend h income/cas annual whereD
(1)
P
P P D
R
1 - t
t
t
1 t
1 t t t

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Question.
If the price of a share on April 1 (current year) is Rs 25, the annual
dividend received at the end of the year is Re 1 and the year-end
price on March 31 is Rs 30, what is the rate of Return ?



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The rate of return = [Re 1 + (Rs 30 Rs 25)] / Rs 25 = 0.24 = 24
per cent.

The rate of return of 24 per cent has two components:

(i) Current yield, i.e. annual income beginning price =
Re 1/Rs 25 = 0.04 or 4 per cent


and

(ii) Capital gains/loss = (ending price beginning price)
beginning price

(Rs 30 Rs 25)/ 25 = 0.20 = 20 per cent.
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Return of A Security
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The expected rate of return on a
security represents the mean of a
probability distribution of possible future
returns on that security.

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The table below provides a probability distribution for the returns on
stocks A and B

State Probability Return On Return On
Stock A Stock B
1 20% 5% 50%
2 30% 10% 30%
3 30% 15% 10%
4 20% 20% -10%
Calculate the Expected Returns for Stock A & B.
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The expected return for stock A& B would be calculated as follows:

E[R]
A
= .2(5%) + .3(10%) + .3(15%) + .2(20%) = 12.5%


E[R]
B
= .2(50%) + .3(30%) + .3(10%) + .2(-10%) = 20%
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Risk and Return of Portfolio
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Portfolio
A portfolio means a combination of
two or more securities.



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Portfolio rate
of return
=
fraction of portfolio
in first asset
x
rate of return
on first asset
+
fraction of portfolio
in second asset
x
rate of return
on second asset
(
(
(
(
)
)
)
)
Expected Portfolio Return
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You invest 47% of your portfolio in Reliance
Energy and 53% in Grasim Industries. The
expected return on your Reliance Energy stock is
17% and on Grasim is 14%. The expected return
on your portfolio is ?
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Expected Return (.47 17) (.53 14) 15.41%