RISK AND RETURN ANALYSIS

ON EQUITY SHARE

The Risk and return analysis is important to equity shares investors in the share market. The need

of equity shares at the time of preliminary stage of company or bank to raising fund for establish

company and starting a business. The equity share holder is an actual owner of company or bank.

The risk and return analysis is main function of this project. The meaning risk and return as

follows:

Risk - risk refers to the possibility that the actual outcome of an investment will differ from

expected outcome. More specifically, most investors are concerned about the actual outcome

being less than the expected outcome.

There are many sources of risk i.e. business risk, market risk, interest rate of risk.

Return – return is representing the reward for undertaking investment. The returns of an

investment consist of two components as under:-

1) Current return

2) Capital return.

In this project risk and return calculated using various techniques. The return is calculate using

net asset value, rate return, dividend, geographical mean and risk is calculate using co-variance,

geometric mean, beta, standard deviation, correlation(using statistical methods).The rate of

equity shares has not fixed. The rate of equity shares of particular company or bank is change at

every time. The equity share holder either can earn profit or can take risk. This situation is not

fixed and hence, here need of risk and return analysis project

Shares that carry no preferential or special right in respect of annual dividend and in the

repayment of capital at the time of liquidation of the company are called equity shares. These

shares carry no preferential rights; therefore, these are also known as common stock or

ordinary shares.

Dividend on such shares is payable only when there are profit after the payment of

preferences dividend. But, the rate of dividend of these shares is not fixed. Board of

directors, depending upon the dividend policy as well as the availability of profit after

dividend on preference shares, declare dividend. No dividend will be paid on these shares, if

there are no profits or insufficient profit in a particular year. The value of these shares in stock

exchange fluctuates on the basis of rate of dividend declared.

Similarly, these shares are redeemed only after the redemption of preference shares at the

time of liquidation of the company. Equity share holders enjoy full voting rights in all market

of the company. They have right to elect directors and participate in the management and

control of the company. They also share residual profits.

What Is the Meaning of Equity Share Capital?

Companies raise two types of capital to source money for their operations: debt capital and

equity capital. Debt capital is procured through lender loans where lenders are paid interest

on the funds. Equity capital is issued to individuals who want ownership rights in the

company. These investors are issued shares of the company stock. There are two broad

categories in which shares are issued: preference shares and equity shares.

Rights Issue/ Rights Shares

Bonus Shares

Preferred Stock/ Preference shares

Cumulative Preference Shares

Risk, in traditional terms, is viewed as a ‘negative’. Webster’s dictionary, for instance, defines

risk as “exposing to danger or hazard”. The Chinese symbols for risk, reproduced below, give

a much better description of risk

The first symbol is the symbol for “danger”, while the second is the symbol for

“opportunity”, making risk a mix of danger and opportunity.

Types of Risk

Systematic risk Interest Rate Risk 1. Price Risk 2.Reinvestment Rate Risk Market risk Inflation Risk (Purchasing Power Risk)

Unsystematic risk Business risk

Financial Risk

Operational Risk

Types of Risk in finance

Systematic Risk

Interest Rate Risk

Price Risk

Reinvestment Risk

Market RiskInflationary

Risk

Demand inflation risk

Cost inflation risk

Unsystematic Risk

Business Risk Financial RiskOperational

Risk

returns are greater than the rate of inflation.

An investor will look forward to getting compensated by way of an expected return based on

3 factors -

Risk involved

Duration of investment [Time value of money]

Expected price levels [Inflation]

Investors make investment with the objective of earning some tangible benefit

Low risk leads to low returns. For instance,

incase of government securities, while the rate of return is low, the risk of defaulting is also

low.

High risks lead to higher potential returns, but may also lead to higher losses

Rate of return on an investment cal be calculated using the following formula-

Return = (Amount received - Amount invested) / Amount invested

A direct correlation exists between risk and return and is illustrated in Figure. The greater the

risk, the greater is the potential return. However, investing in securities with the greatest

return and, therefore, the greatest risk can lead to financial ruin if everything does not go

according to plan.

Understanding the risks pertaining to the different investments is of little consequence unless

you’re aware of your attitude toward risk. How much risk you can tolerate depends on many

factors, such as the type of person you are, your investment objectives, the dollar amount of

your total assets, the size of your portfolio, and the time horizon for your investments.

In the recent past the market has reached great heights as a result of expansion of business

and much more of globalization, the increased percentage of Foreign Direct Investment

which has a direct affect on the demand and supply of the shares of a particular company. In

this way the index of the stock market has reached to the maximum. With the boom in the

market there are many investors who are willing to take more risk and so to cover the risk.

Financial sector is booming and the need for Risk-Return Analysis is growing. Also because

of the very tricky stock market behaviors it has become mandatory to manage portfolio so as

to reduce the risk while maximizing the returns. Taking into consideration the investor’s

riskreturn

requirements portfolio should be constructed and reviewed regularly.