Risk And Return Part II
Risk and Return -II
PGDM/MMS- SEM-II
PROF. V. RAMACHANDRAN
FACULTY- SIESCOMS , NERUL
1
PORTFOLIOS & RISK
What is an Investment Portfolio
A group of Assets that is owned by an
Investor
Single Security is riskier than Investing in a
Portfolio.
Portfolio may contain- Equity Capital, Bonds ,
Real Estate, Savings Accounts, Bullion,
Collectibles etc.
In other words the Investor does not put all his eggs in to one Basket.
2
Diversification –Risk Reduction
Let us assume you put your money equally into the
stocks of two companies Banlight Limited, a manufacturer of sunglasses and Varsha Limited, a manufacturer of rain coats.
If the monsoons are above average in a particular year, the earnings of Varsha Limited would be up leading to an increase in its share price and returns to shareholders.
On the other hand, the earnings of Banlight would be on the decline, leading to a corresponding decline in the share prices and investor's returns.
If there is a prolonged summer the situation would
3
be just the opposite.
Diversification –Risk Reduction
While the return on each individual stock might
vary quite a bit depending on the weather but the return on your portfolio (50% Banlight and 50%
Varsha stocks) could be quite stable because the decline in one will be offset by the increase in the other. In fact, at least in theory, the offsetting could eliminate your risk entirely.
The table below gives the returns on the two stocks on the assumption that rainy, normal and sunny weather are equally likely events (l/3 probability each). Let us calculate the expected return and standard deviation of the two stocks individually and of the portfolio of 50% Banlight and 50% Varsha stocks. 4
Diversification –Risk Reduction
5
Standard Deviation - Computation
6
Standard Deviation - Computation
7
Diversification –Risk Reduction
Where
VAR(k) is Variance of returns.
Pi is Probability associated with ith possible item.
Ki is rate of return
PGDM/MMS- SEM-II
PROF. V. RAMACHANDRAN
FACULTY- SIESCOMS , NERUL
1
PORTFOLIOS & RISK
What is an Investment Portfolio
A group of Assets that is owned by an
Investor
Single Security is riskier than Investing in a
Portfolio.
Portfolio may contain- Equity Capital, Bonds ,
Real Estate, Savings Accounts, Bullion,
Collectibles etc.
In other words the Investor does not put all his eggs in to one Basket.
2
Diversification –Risk Reduction
Let us assume you put your money equally into the
stocks of two companies Banlight Limited, a manufacturer of sunglasses and Varsha Limited, a manufacturer of rain coats.
If the monsoons are above average in a particular year, the earnings of Varsha Limited would be up leading to an increase in its share price and returns to shareholders.
On the other hand, the earnings of Banlight would be on the decline, leading to a corresponding decline in the share prices and investor's returns.
If there is a prolonged summer the situation would
3
be just the opposite.
Diversification –Risk Reduction
While the return on each individual stock might
vary quite a bit depending on the weather but the return on your portfolio (50% Banlight and 50%
Varsha stocks) could be quite stable because the decline in one will be offset by the increase in the other. In fact, at least in theory, the offsetting could eliminate your risk entirely.
The table below gives the returns on the two stocks on the assumption that rainy, normal and sunny weather are equally likely events (l/3 probability each). Let us calculate the expected return and standard deviation of the two stocks individually and of the portfolio of 50% Banlight and 50% Varsha stocks. 4
Diversification –Risk Reduction
5
Standard Deviation - Computation
6
Standard Deviation - Computation
7
Diversification –Risk Reduction
Where
VAR(k) is Variance of returns.
Pi is Probability associated with ith possible item.
Ki is rate of return