Risk and Return Relationship

RISK AND RETURN RELATIONSHIP There is a positive relationship between risk and return. The riskier the investment, the higher the expected return and the larger the range of potential outcomes. Investment relies on two basic types of risk: Specific Risk: relates to a specific company or an asset. It can be diversified away. Systematic Risk: relates to the entire market. It cannot be diversified away. RISK & RETURN GRAPH Risk is on the horizontal axis and return on the vertical axis. The graph shows a relationship between the expected return on a risky asset and its systematic risk. The graph illustrates how as risk increases, so does the expected return. The risk-free rate of return is the return on an investment with zero risk. The slope of the line reflects the risk premium per unit of risk. A rational investor will accept more risk only if they are compensated for it with a higher expected return. An investor's attitude toward risk determines which point on the line they will choose for their investment. A risk-averse investor will choose a lower-risk, lower-return investment, while a risk-tolerant investor will choose a higher-risk, higher-return investment. PHARMACOLOGY Techniques of Risk Evaluation Risk-Adjusted Discount Rate: This is based on pranage that riskier projects require a higher rate of return to compensate for the additional risk. Certainty-Equivalent Method: This method adjusts the expected cash flows of a project to reflect the investor's attitude toward risk. Sensitivity Analysis: This method examines how sensitive a project's outcome is to changes in a single variable. It helps identify which variables have the greatest impact on the project's profitability. Probability: This technique assigns probabilities to different outcomes of a project. It helps to quantify the likelihood of success or failure. Standard Deviation: This is a measure of the dispersion of a set of data from its mean. In finance, it is used to measure the volatility of an investment's returns. Coefficient of Variation: This is a measure of relative variability. It is the ratio of the standard deviation to the mean. It is used to compare the risk of two or more investments with different expected returns. Left Column Q9 Explain different forms of Dividend & determinants of dividend policy? Ans The term dividend refers to that part of profit of a company which is distributed by the company among its shareholders. Forms of Dividend (a) Cash Dividend -> If the dividend is paid in the form of cash to the shareholders, it is called cash dividend. It involves movement of cash from the firm to from the pocket of shareholders. It affects liquidity of the firm also. (b) Stock dividend -> It means issue of bonus shares to existing shareholders. If a company does not have liquid resources it is better to declare stock dividend. It is also called Capitalisation of reserves. (c) Bond dividend -> It is also called Scrip dividend. A bond dividend promises to pay the shareholders at a future specific date. If a company does not have sufficient funds to pay dividend in cash, it may issue bonds for dividends due to shareholders. (d) Property dividend -> Property dividend are paid in the form of some assets other than cash. They are distributed under exceptional circumstances & are not popular in India. Right Column Factors affecting Dividend Policy 1) Liquidity -> Liquidity means Availability of sufficient funds in the business. The liquidity position of a company on important consideration in paying dividend. If company does not have liquid resources, it is better to declare stock dividend or issue of bonus shares to existing shareholders. 2) Age of the Company -> The age of company also influences the dividend decision of a company. A newly established concern has to limit payment of dividend & retain substantial part of earnings for financing its future growth & development. While older companies which have established sufficient reserves can afford to pay liberal dividends. 3) Nature of Industry -> In case of industries future sales & earnings fluctuate so much companies, then conservative dividend policy followed. on other side, in case of pharmaceutical future sales & earnings one stable & regular stable dividend policy followed. 4) Desire In Control -> If mgt does not want to dilute control, it prefers owner retained earnings to pay less dividend.