Investment Risk Management

Investment
Investment is the employment of money or capital in
order to gain profitable returns, as interest, income, or appreciation in value, over a given point of time.

Characteristics of Investment
1. 2. 3. 4. 5.

It is not saving Employment of capital takes place Risk related constraints exist Time horizon depend on risk-return profile Capital appreciation may or may not happen

Importance of Investment
1. 2. 3. 4. 5. 6.

Financial Independence Increase wealth Fulfilling personal & family goals To beat inflation Preparation for adverse condition For the growth of country

Investment alternatives
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Non-Marketable Financial Assets Equity Shares Bonds Money Market Instruments Commodities Mutual Fund Life Insurance Policies Real Estate Precious Objects Financial Derivatives

Criteria for evaluation of investment

y Rate of Return y Risk y Marketability : liquid, low cost, less volatile y Tax Shelter y Convenience

Return
It is the reward for the employing capital or asset over a given point of time. 0r Reward for the investment

Components of Return
1.

Current Return

2. Capital Return

Total Return = Current return + Capital Return Note: Current Return may be +ve or zero, whereas capital return ve, zero or +ve.

Rate of return = Annual Income + (ending price Beginning price) / Beginning Price R = C + (Pe Pb) / Pb Eg. Price at beg. Rs. 60 Dividend paid towards the end of the year Rs. 2.40 Price at the end of the year Rs. 66 What is Total return, current return & Capital Return?

Risk
Risk refers to the possibility that actual outcome of an investment will differ from its expected outcome . Sources of Risk 1. Business risk 2. Interest risk 3. Market Risk

Types of Risk
Broadly we can it divide on the basis its nature Systematic risk Eg. Market Risk, Interest risk, Inflation etc 2. Unsystematic risk Eg. Financial Risk , Business Risk
1.

Risk-Return relationship

y The relationship between risk and return is a fundamental financial relationship that affects expected rates of return on every existing asset investment. The Risk-Return relationship is characterized as being a "positive" or "direct" relationship meaning that if there are expectations of higher levels of risk associated with a particular investment then greater returns are required as compensation for that higher expected risk. Alternatively, if an investment has relatively lower levels of expected risk then investors are satisfied with relatively lower returns.

-This risk-return relationship holds for individual investors and business managers. Greater degrees of risk must be compensated for with greater returns on investment. Since investment returns reflects the degree of risk involved with the investment, investors need to be able to determine how much of a return is appropriate for a given level of risk. This process is referred to as "pricing the risk". In order to price the risk, we must first be able to measure the risk (or quantify the risk) and then we must be able to decide an appropriate price for the risk we are being asked to bear. -This module provides the student with an understanding of various forms of risk that allow the incorporation of risk adjustments into financial management decision making and the asset pricing processes. In the introductory discussions, different types of risk are defined and explored. At more advanced levels, various definitions of risk are quantified and with the help of financial theory, appropriate risk adjusted returns are