Risk and return analysis in financial management
Risk and return are related.Increased potential returns on investment are usually accompanied by increased risk.Different types of risks include project-specific risk.Gains and losses are made from trading a security.
A random variable that takes any value within a given range is considered the return on an investment.The type of returns that investors can expect from trading in the markets are influenced by a number of factors.
Diversification reduces the risk associated with the portfolio but may limit the potential returns.If you invest in only one market sector, you may experience lower returns than if you invested in a broadly diversified portfolio.
First, each investment in a diversified portfolio Capital Allocation Line (CAL) and Optimal PortfolioStep by step guide to constructing the portfolio frontier and capital allocation line.The capital allocation line graphically depicts the risk-and-reward profile of risky assets and can be used to find the optimal portfolio.Any risk that increases or reduces the value of that particular investment or group of investments will have a small impact on the overall portfolio.
The effects of firm-specific actions on the prices of individual assets.An individual who owns stock in a company is called a shareholder and is able to claim part of the company's residual assets and earnings.A portfolio can be positive or negative for each asset for any period.In large portfolios, it can be argued that positive and negative factors will average out so as not to affect the overall risk level of the portfolio.
The higher the correlation in returns between two assets, the smaller the potential benefits.
The risk is best measured by looking at the actual returns around the expected return.The capital asset pricing model shows the relationship between expected return and risk of a security.The CAPM formula shows the return of a security is equal to the risk-free return plus a risk premium.There are multiple sources of market risk that can be examined with the multifactor model.Firms that have been correlated with high returns in the past are used to measure market risk.
The risk is measured by the likelihood that the promised cash flows will not be delivered.Investments with higher default risk usually charge higher interest rates, and the premium that we demand over a riskless rate is called the default premium.Default premiums will be included in interest rates even in the absence of ratings.Default risk-adjusted interest rates are the cost of borrowing for a business.