Fundamentals of Financial Management, Third Edition

3

Concept of Risk and Return

OBJECTIVES

To describe the concept of returns from investment

To explain how returns are estimated based on the theory of probability

To describe the concept of risk

To show how risk is computed in case of a single investment/portfolio of investments

To analyse systematic/unsystematic risk in a Capital-Asset-Pricing Model (CAPM) framework

The returns from an investment cannot be thought of in isolation of the risk factor. Since the future is uncertain, there is always a chance that the returns will be either better or worse than anticipated. The larger the variation in returns, the greater the involvement of the risk factor.

The terms risk and uncertainty are often used synonymously. However, there is difference ...