10/08/2013

Concept of Risk and Return with Diagram

Concept of Risk and Return


Concept of Risk and Return in financial investment, finance, investment, securities, analysis are given in the diagram below.

Concept of Risk and Return

Image credits © Manoj Patil.

Risk


In concept of risk and return, every financial decision involves risk. In financial management, the risk is defined as “the variability of expected returns from an investment”. Risk in investment from investor's view implies that the actual return may not be as expected. From the point of view of a firm, when the actual return is not same as estimated, it is considered as risk. Higher the variations in results, higher is the risk and vice-versa.

Types of Risks that Involved in Investments


Types of risks that involved in investments are given in the diagram below.

Types of Risks that Involved in Investments

Image credits © Manoj Patil.

  1. Capital Risk
  2. Income Risk
  3. Default Risk

Capital Risk


It refers to a capital loss because of fall in the the market price of a security like Equity Shares.

Income Risk


It refers to variations in return from a security. For E.g. In case of Equity Shares dividends vary every year.

Default Risk


It refers to default in payment of interest or repayment of the principal amount by the company.

The element of risk varies with the type of investment. For E.g.: Business Portfolio risks, Financial risks, Legal and Statutory risks, Internal process risks, Social, political and economic risks.

Return


In concept of risk and return, return means “the motivating force and the principal reward in the investment process.” Return can be realized or expected.

In concept of risk and return, realized return refers to the return which was earned or could have been earned. Expected return refers to the return which the investor expected to earn in the future. The return is calculated as a percentage on the initial amount invested.

In concept of risk and return, Returns always comes in the given forms:

  1. In concept of risk and return, the investor should get proper and regular payment of interest on a dividend.
  2. In concept of risk and return, the investor should get safety on the investment that he has invested.
  3. In concept of risk and return, there must be hassle-free deals should be available to the investor in buying and selling of his investment.
  4. In concept of risk and return, the investor should get liquidity on their investment.
  5. In concept of risk and return, there are possibilities of fund's appreciation.

Concept of Risk and Return Example


Examples on Concept of risk and return are follows:

In concept of risk and return, the simple investment management rule is that higher the risk, greater should be the return and vice versa For E.g.: Low risk instruments like small savings bring low returns. High-risk securities like equity shares, bring higher returns.

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