Page 89 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 5: Risk and Return Analysis

Notes
Return % -10 -15 5 12 10 20 13
Probability 0.03 0.02 0.15 0.25 0.3 0.1 0.05

Question
Now after getting all the details, what would you suggest, whether to invest in the
securities or not and what would be your expected rate of return & risk in terms of
standard deviation. Also give your comments based on the average rate of return, variance
and beta value for the company’s securities.

5.6 Summary

 Risk is the chance of financial loss.
 Some risks directly affect both finance managers and the shareholders whereas some risks
are from specific and some are shareholders specific.
 Sensitivity analysis and probability distribution can be used to assess the general level of
risk associated with a single asset.

 Probability distribution provides a more quantitative insight into an assets risk.
 The risk of asset in addition to range can be measured quantitatively by using statistical
methods – the standard deviation and the co-efficient of variation.

 The coefficient of variation (CV) is a measure of relative dispension that is useful in
comparing the risk of assets with differing expected returns

 The risk of a portfolio can be measured in terms of variance or standard deviation.
 The correlation coefficient will always be between +1 and –1.
 The part of the risk that can be totally reduced through diversification is called unsystematic
risk and the part of the risk that cannot be reduced through diversification is called systematic
risk.
 Capital Asset Pricing Model (CAPM) provides a framework for measuring the systematic
risk of an individual security and relates it to the systematic risk of a well diversified
portfolio.

5.7 Keywords

Beta: It is a measure of the systematic risk of a security that cannot be avoided through
diversification.
Correlation: It is a statistical measure that indicates the relationship between series of number
representing anything from cash flows to test data.
Covariance: It is the measure of their co-movement, expressing the degree to which the securities
vary together.
Non-systematic Risk: The variability in a security is total returns not related to overall market
variability.

Portfolio: It is a collection of securities
Risk: Probability that the expected return from the security will not materialize.
Systematic Risk: Variability in a security is total returns that are directly associated with overall
movements in the general market or economy is called systematic risk.

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