RETURN ON INVESTMENT

Investor will always expect that his investments will bring him some benefits. The
benefits could in the form of actual monetary gain, or increase of value of the asset.

Example:

 In bank deposits there will be interest

 In buying a parcel of land (real property), the benefit will be in the form
asset appreciation

Since there are lots of possible investment opportunities, a serious investor will
always be interested to know the profitability of his current investment. This is very
important for him to make a decision whether to continue in a particular kind of
investment, or withdraw/recover the invested funds and invest it somewhere else.

Think About these options:

INVESTMENT RETURN

Progreso bond 2.625% per annum

Time deposits 1.30% - 3.875% per annum

The aforementioned examples, which we can safely assume to be risk-free, are

only some of various investment options. Assuming that after computing the rate of
return of your current investment, you found out that it only gives you 1.85% average
gain per year, it will be a wise business decision to divest or sell off such asset and just
put it in time deposit.

SOURCES OF RISK
 Generally, in any kind of investment, there will always be a possibility of loss.
Depending on the situation and the nature of investment, there is this possibility that the
realized return is lower than the expected return. Actually, how to perfectly assess and
to avoid risk are the perennial dilemmas of investors. No one has ever invented a
perfect formula to address it.

Risk may be classified into:

1. Diversifiable risk
2. Non-diversifiable risk

“A diversifiable risk refers to the risk associated with the individual asset.” 1

The sources of diversifiable risk are:

A. Business risk – pertains to the nature of company’s business operation.

B. Financial risk – pertains to how the company finances its acquired assets.

Example:

The Business risk of Cebu Pacific Airlines depends on, among others, the
following factors:

1. Fuel Cost
2. Number of passengers

The Financial risk of Cebu Pacific Airlines depends on how it finances its very
important assets, airplanes. Were those assets acquired using its own funds, by issuing
bonds and/or shares of stock, or by obtaining loan from a bank. Using the company’s
own funds in acquiring assets will obviously reduce, financial risk.

Investors can minimize this diversifiable risk by investing in different kinds of

securities, i.e. debt securities, equity securities, and derivatives.

1
Basic Finance, by: Herbert Mayo, 11th edition, p. 137
 “Non-diversifiable risk (systematic risk) is a risk associated with non-firm
specific factors”2 such as:

1. Fluctuations in securities prices

2. Changes in interest rates
3. Inflation
4. Fluctuations in exchange rates

STANDARD DEVIATION

Risk is associated with the uncertainty that the realized return will be equal to
the expected return. Knowing this reality in investment, a serious investor will try to
measure his risk exposure and make a decision base on his findings. There are many
methods of measuring risk, one of which is by using the standard deviation.

“Standard deviation emphasizes the extent to which the return differs from the
average or expected return”3. The larger dispersion around the expected return is an
indication of riskier investment.

xxx

2
Basic Finance, by: Herbert Mayo, 11th edition, p. 139

3
Basic Finance, by: Herbert Mayo, 11th edition, p. 140