Page 81 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes

Notes It is significant to note that beta measures a security’s volatility, or fluctuations in
price, in relation to a benchmark, the market portfolio of all stocks.
Beta is useful for evaluating the relative systematic risk of different stocks and, in practice, is
used by investors to judge a stock’s riskiness. Stocks can be ranked by their betas. As the variance
of the market is constant across all securities for a specific period, ranking stocks by beta is the
same as ranking them by their absolute systematic risk. Stocks with high betas are said to be
high-risk securities.

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Caution Beta is a comparative measure of the risk of an individual stock relative to the
market portfolio of all stocks.

Self Assessment

State whether the following statements are true or false:

3. Investors and analysts should be at least to some extent familiar with the study of
probability distributions.
4. Beta is useful for evaluating the relative unsystematic risk of different stocks.

4.3 Risk and Expected Return

Risk and expected return are the two major determinants of an investment decision. Risk, in
easy terms, is linked with the variability of the rates of return from an investment; how much do
individual outcomes deviate from the expected value? Statistically, risk is measured by any one
of the measures of dispersion such as co-efficient of range, variance, standard deviation etc.
The risk involved in investment depends on various factors such as:
1. The length of the maturity period, longer maturity periods impart greater risk to investments.

2. The credit-worthiness of the issuer of securities, the ability of the borrower to make
periodical interest payments and pay back the principal amount will impart safety to the
investment and this lessens risk.

3. The nature of the instrument or security also ascertains the risk. Generally, government
securities and fixed deposits with banks tend to be risk less or least risky; corporate debt
instruments like debentures be inclined to be riskier than government bonds and
ownership instruments like equity shares tend to be the riskiest. The comparative ranking
of instruments by risk is once again connected to the safety of the investment.
4. Equity shares are believed to be the most risky investment on account of the variability of
the rates of returns and also for the reason that the residual risk of bankruptcy has to be
borne by the equity holders.
5. The liquidity of an investment also decides the risk involved in that investment. Liquidity
of an asset refers to its quick saleability without a loss or with a minimum of loss.

6. In addition to the aforementioned factors, there are also several others such as the economic,
industry and firm specific factors that affect the risk an investment. A thorough analysis of
these risk factors will be taken up in the next unit.

Another foremost factor determining the investment decision is the rate of return expected by the
investor. The rate of return expected by the investor comprises of the yield and capital appreciation.

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