Beruflich Dokumente
Kultur Dokumente
By
Barun Jit Maitra
Roll No-04
PGDM 09-11
What is RISK?
TIME Risky
Security
Conservative
Market
Effect Of Diversification
State of Probability Return Return On Return on
Economy on A (%) B (%) Portfolio
1 0.25 15 -5 5(%)
2 0.25 -5 15 5
3 0.25 35 5 20
4 0.25 25 35 30
•
•
• Expected return on stock A, E (A) =
0.25(15%) + 0.25(-5%)+0. 25(35%)
+0. 25 (25%) = 17.5%
•
• Expected return on stock B, E (B)
=0.25(-5%) +0 .25(15%)+.0 25(5%)
+0.25 (35%) = 12.5%
= 14.79%
• Standard Deviation on stock B,= 25(-5-
12.5)2 + .25(15-12.5)2+. 25(5-12.5) 2 +.
25 (35-12.5) 2
=
√218.75 =14.79%
• Standard Deviation on portfolio, A and B
=25(5-15)2 + .25(5-15)+. 25(20-15)2+.
25 (30-15)2
=
√87.5 = 9.35 %
• So, from the above as we can interpret
Relationship between
diversification and risk
Market Risk Measurement
• The sensitivity of a security to market
movements is called beta (β)
• Measure of the extent to which the
return on a security fluctuates with
the return on market portfolio
• By definition, the beta for the market
portfolio is 1
• A security which has a beta of 1.5 is
experiences greater fluctuation
than the market portfolio
Calculation of Beta
20, 27.5
25 15, 25
20
15 15, 15
10
Return on asset
0
-15 -10 -5 0 5 10 15 20 25
-5, -5 -5
-10
-10, -17.5
-20
Return on market
• Determinants of Beta
•
• 1. Cyclicality of revenues – How responsive are revenues
to changes in the business cycle?
• Does the firm produce normal goods or inferior goods?
• Highly cyclical high covariance with the market high
beta.
•
• 2. Operating Leverage (Degree of Operating
Leverage) – Degree to which costs are fixed.
• High FC relative to VC high operating leverage
•
• Contribution margin = Price – VC = incremental profit from
an additional sale
•
• Low Contribution margin = low FC & high VC = low DOL –
example is grocery store
• High Contribution margin = high FC & low VC = high DOL –
example is airline
• High Operating Leverage profits are more responsive to
• 3. Financial Leverage – similar to operating leverage if
we think of debt as a FC
•
• Equity = Equity beta = beta of a firm’s stock. This is
what we have been measuring and looking at thus far.
It is a measure of both the firm’s business risk and its
financial risk.
•
• Asset = Asset beta = weighted average of the betas of
all a firm’s securities (common stock, debt and
preferred stock). This is a measure of the firm’s
business risk only.
•
• Asset = Debt (D) + Equity (E)
• D+E D+E
•
• If a firm has no debt, Asset = Equity
• So, we can think of Asset as what Equity would be if the
firm had no debt – if it is an unlevered firm.
•
To Summarize
• Securities are risky because their returns
are variable
• The most commonly used measure of
risk is σ
• Risk of a security-------Unique and Market
• Unique------Firm specific factors
• Market------ Economy wide factors
• Portfolio Diversification washes away
Unique risk
• The risk of a fully diversified portfolio is
its Market Risk
• Contribution of a security to the risk of a
fully diversified portfolio is beta
THANK YOU