Hello, What is the concept of risk and return of a single asset and a portfolio? The fact is, most investors invest their funds in more than one security suggestion, that there are other factors besides returns, and they should be considered. Investors not only like returns but also dislike risk. So, what is required is. A clear understanding of what is the risk and return, ii. What makes them and iii. How can they be measured?
What is example of unsystematic risk?
Return is the core driving force and the major return in the investment process. Return can be defined in terms of (i) the realized return, that is, the return that has been earned, and (ii) the expected return, that is, the return that the investor hopes to earn in some future investment period. Does.
The expected return is and may or may not be an expected return. Returns received in the past allow an investor to estimate cash flow in terms of dividends, interest, bonuses, capital gains, etc. available to the holder of the investment.
Return can be measured as the total profit or loss a holder has over a given period of time and can be defined as the percentage return on an investment that was initially invested. In the context of investing in equity shares, a dividend at the time of sale of these shares consists of dividends and capital gains or losses.
Risk in investment analysis means that future returns from an investment are unpredictable. The concept of risk can be defined as the probability that, real returns may not be predictable.
- In other words, risk refers to the probability that the actual result (return) from the investment will be different from the expected one. In the context of a firm, risk can be defined as the probability that the actual outcome of a financial decision may not be predictable.
- Risk can in turn be considered a chance of differentiation. Investments with a higher probability of variance are considered riskier than those with a low probability of variance. Between equity shares and corporate bonds, the former is riskier than the latter.
- If corporate bonds are held until maturity, then annual interest flows and maturity repayments are fixed. However, in the case of equity investment, neither the dividend flow nor the terminal value is fixed. Risk must be differentiated with uncertainty.
- Risk is defined as a situation where the probability of an event occurring or not can be quantified and measured, while uncertainty is defined as a situation where this probability is not measured. Can go
- Thus, the risk is a situation when probability can be assigned to an event based on the available facts and figures regarding the decision. On the other hand, uncertainty is a situation where either facts and figures are not available, or probabilities cannot be assigned.
What are the types of unsystematic risk?
1. Systematic Risk: It refers to that portion of the variability in return which is caused by the factors affecting all the firms. It refers to the 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. these are the factors that affect almost all firms.
The effect of these factors is to cause the prices of all securities to move together. This part of risk arises because every security has a built-in tendency to move in line with fluctuations in the market. No investor can avoid or eliminate this risk, whatever precautions or diversification may be resorted to. The systematic risk is also called the non-diversifiable risk or general risk.
2. Market Risk: Market prices of investments, particularly equity shares may fluctuate widely within a short span of time even though the earnings of the company are not changing. The reasons for this change in prices may be varied. Due to one factor or the other, investors’ attitudes may change towards equities resulting in the change in market price. Change in market price causes the return from investment to very.
This is known as market risk. The market risk refers to variability in return due to a change in the market price of the investment. The market risk appears because of the reaction of investors to different events. There are different social, economic, political, and firm-specific events that affect the market price of equity shares.
Market psychology is another factor affecting market prices. In bull phases, market prices of all shares tend to increase while in bear phases The prices tend to decline. In such situations, the market prices are pushed beyond far out of line with the fundamental value.
3. Interest-rate Risk: interest rates on risk-free securities and general interest rate levels are related to each other. If the risk-free rate of interest rises or falls, the rate of interest on the other bond securities also rises or falls. The interest rate risk refers to the variability in return caused by the change in the level of interest rates.
Such interest rate risk usually appears through the change in the market price of fixed income securities, i.e., bonds and debentures. Security (bond and debentures) prices have an inverse relationship with the level of interest rates. When the interest rate rises, the prices of existing securities fall and vice-versa.
4. Purchasing power or Inflation Risk: The inflation risk refers to the uncertainty of the purchasing power of cash flows to be received out of the investment. It shows the impact of inflation or deflation on the investment. The inflation risk is related to interest rate risk because as inflation increases, the interest rates also tend to increase. The reason being that the investor wants an additional premium for inflation risk (resulting from a decrease in purchasing power).
Thus, there is an increase in the interest rate. Investment involves a postponement in present consumption. If an investor makes an investment, he forgoes the opportunity to buy some goods or services during the investment period. If, during this period, the prices of goods and services go up, the investor losses in terms of purchasing power. The inflation risk arises because of the uncertainty of the purchasing power of the amount to be received from investment in the future.
5. Systematic Risk: Uncertainty risk represents return fluctuations from investment due to factors that are specific to a particular firm and not the market. These factors are largely independent of the factors affecting the market in general. Since these factors are unique to a particular firm, they should be examined separately for each firm and each industry. These factors can also be called firm-specific, as they affect one firm without affecting other firms.
For example, fluctuations in the price of crude oil will affect the fortunes of petroleum companies but not textile manufacturing companies. As irregular events result in random events that are unique to an industry or firm, this risk is random in nature. Involuntary risk is also called specific risk or miscellaneous risk.
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