Page 86 - DCOM507_STOCK_MARKET_OPERATIONS

Unit 4: Risk and Return

Notes
Table 4.3: Security and Portfolio Holding-period Returns
Security Proportion of Current Expected Holding Contribution to Portfolio Expected
Value of Portfolio Period Return (%) Holding Period Return (%)
1 2 3 4
XYZ .0750 20.00 1.50
ABC .1500 10.00 1.50
RST .4000 12.50 5.00
KNF .3125 20.00 6.25
DET .0625 20.00 1.25
1.0000 15.50

As the portfolio’s expected return is a weighted average of the expected returns of its securities,
the input of each security to the portfolio’s expected returns depends upon its expected returns
and its proportionate share of the initial portfolio’s market value. Nothing else is relevant. It
follows that an investor who purely wants the greatest possible expected return should hold one
security. This should be the one that is considered to have the greatest expected return. Only a
few investors do this, and very few investment advisers would counsel such an extreme policy.
Instead, investors should diversify, meaning that their portfolio should include more than one
security. This is because diversification can reduce risk.

Self Assessment

Fill in the blanks:
9. A portfolio is a collection of ............................................
10. The portfolio’s ............................................ returns depend upon its proportionate share of
the initial portfolio’s market value.

4.6 Risk

All probable questions which the investor may ask, the most significant ones are concerned
with the probability of actual yield being less than zero, that is, with the probability of loss. This
is the essence of risk. A useful amount of risk has to somehow take into account both the
probability of a variety of possible “bad” outcomes and their associated magnitudes. Instead of
measuring the probability of a number of different possible outcomes, the measure of risk
should somehow estimate the degree to which the actual outcome is expected to diverge from
the expected.
Two measures are used for this purpose, the average (or mean) absolute deviation and the
standard deviation.

Example: The rate of return of equity shares of Wipro Ltd., for past six years are given
below:
Rate of Return of Equity Shares of Wipro Ltd

Year 01 02 03 04 05 06
Rate of return (%) 12 18 -6 20 22 24

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