Risk and Return of single Asset

Team- 01

Team mates-Atul Sharma

Mohit Verma

Niketa Chaudhary

Prabhat Singh

What is Risk?In common language Hindi it means

“जोखि�म”

a situation involving exposure to danger,  harm, or loss.

Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment.

What is ReturnsIn simple Hindi term Returns is defined as

“प्रति�फल”

The gain or loss of a security in a particular period. The return consists of the income and the capital gains relative on an investment. It is usually quoted as a percentage.

What is Asset?In Hindi it means

“संपत्ति�”Something valuable that an entity owns, benefits from, or has use of, in generating income.

An asset can be (1) something physical, such as cash, machinery, inventory, land and building

Assets

Gold MachineryBuilding

Cash

Risk & Return on Single Investment

Where will the seagull go? Will it fly toward the sea, turn around and walk away? Will it look your way or look to the surf? This range of possibility is one way to see risk. Observing how often the bird flies away, compared to how often it stays can provide us a measure of risk.

Probability Distribution Assessing the risk of an asset requires that we have some

sense for the range of possible outcomes. For example, a judge sentencing a youthful offender might consider the likelihood of different scenarios:

worst case (pessimistic), the offender will commit only another minor crime;

expected case (normal), she will commit no more crimes

best case (optimistic), she will prevent others from committing crimes

Expected Return

What is the expected return when we throw two dice? Suppose the number you throw represents the return, and suppose you throw the dice thousands of times. What would you expect your return to be on average? We can compute the expected return for each possible result and then sum these results.

Standard Deviation This variability can be measured. That is, risk can be

quantified! The most common measure of risk is the standard deviation -- a numerical measure of the dispersion around the expected value. Here is how the standard deviation (designated by s ) is calculated for our two dice probability distributions:

compute the expected return; square the variance of each return from the

expected return; multiply this by the probability; sum these weighted values; calculate the square root of this sum (the standard

deviation).

Normal Distribution

The probability density of the normal distribution is: Here, is the mean or expectation of the distribution (and also its median and mode).

The parameter is its standard deviation with its variance then . A random variable with a Gaussian distribution is said to be normally distributed and is called a normal deviate.

Coefficient of Variation What happens when there are two distributions with

different expected returns? How do you decide which distribution involves greater dispersion and thus greater risk? For example, suppose you are presented with two investment strategies.

Plan A Plan BExpected return 15% 20%Standard deviation 5% 6%

Coefficient of variation .333 .300

Plan A offers a lower expected return, but with less variability, than Plan B. Which is less risky? Actually, Plan B has less relative risk. The coefficient of variation -- that is, the ratio of variability to return -- is higher for Plan A (5/15 = .33) compared to Plan B (6/20 = .30). There is greater relative risk that returns will deviate from the expected return under Plan A.

 Risk of Multiple Assets (Portfolio Risk)

"Put all your eggs in one basket, and then pay very close attention to that basket." 

—Warren Buffet Why are we told not to put all our eggs in one

basket? If we had two baskets and we tripped, might we not lose both baskets anyway? Or if we tripped, but caught ourselves with our right hand, might we not save the full basket in our left hand? What are the assumptions implicit in the eggs-in-one-basket dictum