Different types of risks include project-specific risk, industry-specific risk, competitive risk, international risk, and market risk. Key current questions involve how risk should be measured, and how the required return associated with a given risk level is determined. Nearly all stocks listed on the BSE / NSE move in the same direction as the BSE / NSE index. The investors not only like return but also dislike risk. Business risk arises due to the uncertainty of return which depend upon the nature of business. Portfolio Diversification and Minimization of Risk 6. Learn how your comment data is processed. This possibility of variation of the actual return from the expected return is termed as risk. Financial market downturns affect asset prices, even if the fundamentals remain sound. Anytime you invest money into something, there is a risk… Risk refers to the variability of possible returns associated with a given investment. This site uses Akismet to reduce spam. Your email address will not be published. The trade-off between risk and return is a key element of effective financial decision making. 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Your email address will not be published. The weights of the two assets are 60% and 40% respectively. If you can’t accept much risk in your investments, then you will earn a lower return. Unsystematic risk is also called specific risk or diversifiable risk. Home » Blog » Portfolio Risk – How to measure and manage the risk of your investment portfolio. Financial risk is associated with the way in which a company finances its activities. The business risk may be classified into two kind viz. Higher levels of return are required to compensate for increased levels of risk. Portfolio Risk. Taking on more risk can mean potentially higher returns but there’s also a greater chance of losing money. Stock Market Investing Concept: Risk and Return Background. The concept of risk may be defined as the possibility that the actual return may not be same as expected. The concept of risk may be defined as the possibility that the actual return may not be same as expected. that enable investors to control and manage the risk to which they subject them-selves while searching for high returns. We can use our return per unit of risk metric subject to a minimal return over a multiple time horizons as a filter. What is ‘Risk and Return’? These factors may also be called firm-specific as these affect one firm without affecting the other firms. The returns on investment usually come in the following forms:-The safety of the principal amount invested. We call this excess return over the risk-free return as 'risk premium'. Investment includes the various methods and steps adopted by the prudent investors during the development of their funds in order to earn profit and to minimize risks involved therein. If the consumer price index in a country shows a constant increase of 4% & suddenly jump to 5% in the next. They have a systematic influence on the prices of both stocks & bonds. This site uses Akismet to reduce spam. Most investment decisions revolve around the risk and return conundrum. It relates to the variability of the business, sales, income, expenses & profits. Risk is inseparable from return in the investment world. The lesser the investment risk, more lucrative is the investment. Investment Management Risk and Return 1. Market risk is referred to as stock/security variability due to changes in investor’s reaction towards tangible and intangible events is the chief cause affecting market risk. Socio-political risk: The risk of changes in government, government policies, social attitudes, etc. Uncertainty, on the other hand, is a situation where either the facts and figures are not available, or the probabilities cannot be assigned. Credit risk Credit risk The risk of default that may arise from a borrower failing to make a required payment. On investments made in shares of companies, the periodical payments are not assured but it may ensure higher returns from fixed income securities. In other words, it is the degree of deviation from expected return. Suitable securities are those whose prices are relatively stable but still pay reasonable dividends or interest, such as blue chip companies. Investment risk can be defined as the probability or likelihood of occurrence of losses relative to the expected return on any particular investment. Risk & Return Relationship 1 2. It refers to fluctuation in return due to general factors in the market such as money supply, inflation, economic recessions, interest rate policy of the government, political factors, credit policy, tax reforms, etc. Risk management is the process of identification, analysis, and acceptance or mitigation of uncertainty in investment decisions. A large body of literature has developed in an attempt to answer these questions. Return of Single Asset 4. If the corporate bonds are held till maturity, then the annual interest inflows and maturity repayment are fixed. But these instruments carry higher risk than fixed income instruments. The presence of these interest commitments — fixed interest payments due to debt or fixed dividend payments on preference share — causes the amount of retained earning availability for equity share dividends to be more variable than if no interest payments were required. In investing, risk and return are highly correlated. To compensate for the lower anticipated return, you must increase the amount invested and the length of time invested. Before the selection of investment the investor should keep in mind that certain investment like, Bank deposits, Public deposits, Debenture, Bonds, etc. With reference to investment in equity shares, return is consisting of the dividends and the capital gain or loss at the time of sale of these shares. Inflation eats away the returns and lowers the purchasing power of money. The Webster’s New Collegiate Dictionary definition of risk includes the following meanings: “……. Required fields are marked *. Increased potential returns on investment usually go hand-in-hand with increased risk. Many people, both investors and non-investors alike, have turned their attention to the stock market, giving more attention to the financial markets than during any other time in recent memory. Risk, in this sense, does have a positive side because the uncertainty can translate into high returns as well as low returns. Chapter Objectives At the end of the topic, students should be able to understand the following: Total Risk Risks Associated with Investments Risk Relationship Between Different Stocks Portfolio Diversification of Risk 2 3. In the rest of this chapter we’ll gain a better understanding of the concept of risk and see how it fits into the portfolio idea. 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