RISK &

RETURNS

RISK
Definitions
Generally, it is a probability or threat of damage,
injury, liability, loss, or any other negative occurrence
that is caused by external or internal vulnerabilities,
and that may be avoided through preemptive actions.
It can be defined as the probability that an actual
return on an investment will be lower than the
expected return.
The possibility that shareholders will lose money
when they invest in a company that has debt, if the
company's cash flow proves inadequate to meet its
financial obligations.

RISK - TYPES
The possibility of risk could arise either from internal or
external environment of a particular business. Risk can
mainly be classified into;
1. SYSTEMATIC RISK
.The risks caused by factors external to the firm and
which is uncontrollable by the firm are called so.
.It affects the market as a whole and thereby affects the
industry and ultimately affects the business/firm
hailing to the particular industry.
.It can be caused by the SLEPT factors.
It can be sub divided into;

a) Market Risk:- According to Jack Clark Francis,

Market risk can be defined as that portion of total

variability of return caused by the alternating forces
of bull and bear markets.
When the security index moves
upward halting for a significant period of time, it is
known as bull market. Here the index moves from a
low level to the peak.
Bear market is the just opposite of
bull market, the index declines from the peak to the
market low point called trough for a significant
period of time.

The market risk can be caused due to tangible and

intangible events. Tangible events include natural
calamities, earthquakes, political uncertainty etc.
Intangible events are related to psychology and
perception of the customers towards the fluctuating
share prices.

b) Interest

Rate Risk
The risk faced by investors due to the fluctuations in
interest rate is called so.
The fluctuations in the interest rate affects the prices and
return from shares, debentures and bonds.
The fluctuations in interest rates are caused by the
changes in the government monetary policy and the
changes that occur in the interest rates of treasury bills
and government bonds.
The bonds issued by the government are almost risk
free.
If high interest rates are offered, investors will switch
from private sector bonds to public sector bonds.

c) Purchasing Power Risk

It

can be defined as the probable loss in the purchasing

power of the returns to be received.
Inflation is the main reason behind it.
Inflation can be of demand pull and cost push in
nature.
In demand pull inflation, the demand of goods and
services are in excess of their supply.
In this case, the economy will not be able to supply
more goods in the short-run and the demand for the
goods pushes the price upwards.

The supply cannot be increased unless there is an

expansion of labour force for production.
The equilibrium between demand and supply is attained at
a higher price level.
The cost-push inflation is the inflation or the rise in price
due to increase in the cost.
The increase in cost of factors of production make the cost
of production high and ends in higher price level.
Hence, the producer tries to pass the higher cost of
production to the consumer.
The labourers try to make the corporate to share the
increase in cost by demanding high wages.
Hence cp inflation has a spiralling effect on price level.