Risk-Return Relationship of Different Stocks.pptx

The risk-return relationship is a fundamental concept in investment. It refers to the direct relationship between the risk of a security and its expected return. Different types of stocks carry different levels of risk and therefore offer varying levels of expected return.

1. Risk-Return Relationship of Different Stocks

2. The risk-return relationship is a fundamental concept in investment. It refers to the direct relationship between the risk of a security and its expected return . Different types of stocks carry different levels of risk and therefore offer varying levels of expected return.

3. Blue-Chip Stocks Definition : Stocks of large, financially stable, and reputed companies with a history of stable earnings and regular dividends. Risk : Low Return : Moderate and steady Risk-Return Nature : These are considered low-risk, moderate-return investments. Suitable for conservative investors.

4. Growth Stocks Definition : Stocks of companies expected to grow at an above-average rate compared to the market. They usually reinvest earnings , not paying dividends. Risk : High Return : High capital appreciation potential Risk-Return Nature : These are high-risk, high-return stocks. Suitable for aggressive investors with long-term goals.

5. Defensive Stocks Definition : Stocks that are not much affected by economic cycles , like those in utilities or essential goods. Risk : Low Return : Low to moderate Risk-Return Nature : These stocks provide stable returns even during recessions. They are low-risk, low-return investments

6. Cyclical Stocks Definition : Stocks of companies whose performance is highly correlated with economic cycles – such as automobiles, construction, and steel. Risk : Moderate to High Return : Varies with economy; high in booms Risk-Return Nature : Risk and return fluctuate with business cycles. Returns can be high during booms, but risks increase during downturns.

7. Penny Stocks Definition : Low-priced , highly speculative stocks of small or unknown companies. Often traded over-the-counter. Risk : Very High Return : Highly uncertain, can be extremely high or result in total loss Risk-Return Nature : Extremely high-risk , with potential for both windfall gains and complete loss . Not suitable for average investors.

8. Risk–Return Relationship of Different Stocks 1. Blue-Chip Stocks • Large, established companies • Stable earnings and dividends • 📉 Low Risk | 📈 Moderate Return • Eg : Infosys, Reliance 2. Growth Stocks • Rapidly growing companies • Reinvest profits (no dividends) • 📉 High Risk | 📈 High Return • Eg : Zomato , Paytm 3. Defensive Stocks • Stable in all economic conditions • Essential goods and services • 📉 Low Risk | 📈 Low–Moderate Return • Eg : ITC, HUL

9. 4. Cyclical Stocks • Follow economic cycles • Boom = high profits; Recession = decline • 📉 Moderate–High Risk | 📈 Variable Return • Eg : Tata Motors, JSW Steel 5. Penny Stocks • Low-priced, small companies • High speculation, low info • 📉 Very High Risk | 📈 Uncertain/High Return • Eg : Unknown/small-cap firms Match stock type with investor's risk profile • Diversify to balance risk and return

10. Risk and Expected Return 1. Meaning of Risk: Risk refers to the possibility that the actual return on an investment may differ from the expected return. It is the degree of uncertainty or potential financial loss . 🔁 Higher risk = Greater uncertainty = Potential for higher return 2. Meaning of Expected Return: Expected return is the profit or loss an investor anticipates on an investment over a period, based on historical data or probability estimates . Expected Return (ER)=∑(Pi​× Ri ​) Pi ​ = Probability of each possible return Ri ​ = Return in each scenario

11. Relationship Between Risk and Expected Return: Type Explanation Direct Relationship As risk increases, the expected return also increases. Investor Perspective Risk-averse investors demand higher returns for taking higher risks. Investment Decision Rule Choose investment with highest return for given risk or lowest risk for given return.

12. ^ | R | / E | / T | / U | / R | / N / +-------------------------------> Risk The curve shows that return increases with risk.

13. Example of Expected Return Calculation: Scenario Probability (P) Return (%) (R) P × R Boom 0.3 20 6 Normal 0.5 10 5 Recession 0.2 -5 -1 Total 10% ✅ Expected Return = 10%

14. Importance in Investment Decision : Helps evaluate and compare different assets. Assists in portfolio construction. Balances potential reward with possible risk. “There is no reward without risk." Investors must understand both the potential return and associated risk before making a decision.

15. Portfolio and Security Returns Introduction Return is the gain or loss made on an investment over a period of time. It is expressed in percentage terms and is a key parameter in evaluating investment performance. Investors may invest in single securities (individual shares/bonds) or in a portfolio (a collection of securities).

16. Security Return (Return on a Single Investment) The return on a security refers to the income received plus any capital gain/loss , over the investment period.

17. Components: Dividend or Interest Income – Regular earnings. Capital Gain/Loss – Change in market price. 🔹 Example: Bought a share at ₹100. Sold at ₹120. Received dividend ₹5. Return = (5+(120−100)100)×100=25 %

18. Portfolio Return Definition: The portfolio return is the weighted average return of all the securities in the portfolio. Formula :

19. Example: Security Investment (₹) Return (%) A 20,000 10% B 30,000 15% C 50,000 12% Total investment = ₹1,00,000 Weights: A: 0.20 B: 0.30 C: 0.50 Portfolio Return = (0.20×10)+(0.30×15)+(0.50×12)= 2+4.5+6=12.5%

20. Importance of Portfolio Return Helps in performance evaluation of investment decisions. Aids in comparing with market benchmarks (like Nifty, Sensex). Useful in risk-return trade-off analysis. Crucial for asset allocation and diversification decisions

21. Factors Affecting Security and Portfolio Returns Factor Impact Market trends Influence price changes Economic indicators Affect interest rates, inflation, GDP Company performance Impacts stock value Government policies May influence sectors differently Global events Affect overall market sentiment

22. Realized vs Expected Return Type Meaning Formula Realized Return Actual return earned Based on historical data Expected Return Future return anticipated ∑( Pi×Ri )\sum ( P_i \times R_i ) Pi​ = Probability of return Ri ​ = Possible return

23. Security return = Gain/loss from an individual investment. Portfolio return = Weighted average of individual returns. Used to assess investment performance and guide future decisions . Influenced by market, economic, and company-specific factors . Helps in strategic asset allocation and diversification planning .

24. Importance of Understanding Risk Preferences: 1. Helps in Choosing Suitable Assets Risk-averse investors prefer safe investments like bonds or fixed deposits. Risk-seeking investors may go for equities, commodities, or cryptocurrencies. Understanding preferences ensures the portfolio includes appropriate asset classes. 2. Ensures Risk-Return Balance Investors expect a return that justifies the level of risk they are taking. Risk preference helps in striking the right balance between expected return and acceptable risk .

25. 3. Prevents Emotional Decision-Making A portfolio aligned with the investor's risk tolerance reduces panic during market volatility. It supports long-term discipline and prevents impulsive withdrawals or risky bets. 4. Supports Goal-Based Investing Risk preference helps align investment strategies with financial goals like retirement, education, or buying a house. Short-term goals may require low-risk assets, while long-term goals can accommodate higher risk.

26. 5. Aids in Asset Allocation Risk preference guides how much to invest in equity, debt, gold, or real estate. A conservative investor may allocate more to debt, while an aggressive investor may favor equities. 6. Improves Portfolio Performance Satisfaction A portfolio that matches risk tolerance keeps the investor comfortable and satisfied. This leads to better financial planning and investor retention.