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Risk and Return
Risk refers to the chance that
some unfavorable event will occur.
Risk
is defined in Webster’s as “a hazard; a peril; exposure
to loss or injury”. Thus, risk refers to the chance that
some unfavorable event will occur.
Company specific
risk is caused by such things
as lawsuits, strikes, successful and unsuccessful
marketing programs, the winning and losing of major
contracts, and other events that one unique to a
particular firm.
Market risk
stems from factors which
systematically affect most firms, such as war,
inflation, recessions, and high interest rates that
cannot be eliminated by diversification.
The
rate of return expected to be realized from an
investment; the mean value of the probability
distribution of possible results.
^
n
Expected rate of return =
k =
Σ
Piki
OR
і=1
=
Expected ending value –
Cost
Cost
Probability
distribution is a listing of all possible outcomes, or
events, with a probability (chance of occurrence)
assigned to each outcome.
Measuring
Risk: -
Standard Deviation
( σ ) is a statistical measure of the variability of a
set of observations.
n ^
√ Σ
( ki
– k )² Pi
і=1
Variance
( σ² ) is the square of the standard deviation.
n ^
Σ
( ki
– k )² Pi
і=1
 Coefficient
of variation ( CV ) =
σ
^
k
Standardized
measure of the risk per unit of return; calculated as
the standard deviation divided by the expected return.
Risk Aversion
is a dislike for risk. Risk-averse investors require
higher rates of return on higher-risk securities.
Risk Premium
is the difference between the expected rate of return on
a given risky asset and that on a less risky asset.
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