In finance, return is the reward for investing money, while risk is the uncertainty about actual return. Investors generally require higher expected return for higher risk. A key idea is that not all risk can be removed:
This unit supports CAPM and portfolio thinking used in cost of equity and investment decisions.
You should be able to:
Return is the gain from an investment over a period (income + price change), usually expressed as a percentage.
Risk is variability/uncertainty in returns. Higher uncertainty means higher risk.
Return can include:
Total return (basic): Total return = income + capital gain (over the period).
Risk affecting the entire market/economy:
It cannot be diversified away.
Company/industry-specific risk:
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Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise.
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In finance, return is the reward for investing money, while risk is the uncertainty about actual return. Investors generally require higher expected return for higher risk. A key idea is that not all risk can be removed:
This unit supports CAPM and portfolio thinking used in cost of equity and investment decisions.
You should be able to:
Return is the gain from an investment over a period (income + price change), usually expressed as a percentage.
Risk is variability/uncertainty in returns. Higher uncertainty means higher risk.
Return can include:
Total return (basic): Total return = income + capital gain (over the period).
Risk affecting the entire market/economy:
It cannot be diversified away.
Company/industry-specific risk:
It can be reduced through diversification.
Quick table:
Portfolio means a collection of securities. Diversification means spreading investment across different assets so that poor performance of one asset may be offset by others.
Key idea: Diversification reduces unsystematic risk, but systematic risk remains.
Flow (write/draw): Hold one stock → high company-specific risk → combine multiple stocks → specific risks offset → lower unsystematic risk
Expected portfolio return is the weighted average of expected returns: Where = weight (proportion invested).
Mini example: 50% in A (10%) and 50% in B (14%):
Beta (β) measures systematic risk—sensitivity of a security’s return to market return.
Interpretation:
Mini table:
CAPM gives required return on equity: So, higher β → higher required return.
Total risk → Systematic (market) + Unsystematic (specific)
From this topic
Systematic vs unsystematic risk:
Hence, only unsystematic risk can be diversified away.
Portfolio return (Rp) = wA×RA + wB×RB
= 0.60×10% + 0.40×15% = 6% + 6% = 12%.
Risk–return relationship states that higher risk requires higher expected return.
Investors face uncertainty in cash flows and prices, so they demand compensation over the risk-free return.
Therefore, risky investments must offer higher expected returns to attract investors, otherwise they will prefer safer alternatives.