Risk and Return in Investments

Risk and Return

• Risk is the variability of future returns, the chance of unfavorable events, and the uncertainty of future outcomes.
• Higher variability means greater risk.
• Return is the money made or lost on an investment over a period.
• Return can be expressed as a percentage (profit/investment).

Risk-Return Relationship

• Investment risk is the likelihood of an asset's value decreasing or negative returns.
• Higher potential for asset value increase usually means higher investment risk.
• Risk and return have a direct relationship. Higher potential returns often correlate with greater risk.
• Diversification (investing in varied options) can help reduce overall risk.

Risk Categories

• Systematic Risk (Market Risk): Uncontrollable factors affecting all (or many) companies within an industry or group (e.g., external factors).
• Unsystematic Risk (Asset-Specific Risk): Controllable factors affecting the performance of a specific investment (e.g., asset-specific uncertainties).

Types of Risks

• Political/Regulatory Risk: Impact of political decisions & regulations.
• Financial Risk: Company's capital structure (debt burden).
• Interest Rate Risk: Impact of changing interest rates.
• Country Risk: Uncertainties specific to a country.
• Social Risk: Changes in social norms/movements.
• Environmental Risk: Environmental liabilities & environmental changes.
• Operational Risk: Company's operational uncertainties.
• Management Risk: Decisions of management teams.

Risk Management Strategies

• Diversification: Reducing unsystematic risk by investing in various assets.
• Hedging: Reducing uncertainty through agreements (forwards, options, futures, swaps) with counterparties.
• Insurance: Protecting investments from catastrophic events.
• Deleveraging: Reducing debt to lower expected future financial performance risk.

Primary and Secondary Markets

• Primary Market: Companies sell shares to investors for the first time (Initial Public Offering -IPO-). Often referred to as 'going public.'
• Secondary Market: Investors buy and sell existing shares on a stock exchange.

Return on Shares

• Dividends: Regular income to shareholders, often expressed as a percentage of the share price (dividend yield)
• Capital Gain: Increase in share value; realized when shares are sold.

Types of Bonds

• Government Bonds/Treasury Bonds: Issued by governments, pay periodic interest.
• Corporate Bonds: Issued by companies, used for financing.
• JUNK/High Yield Bonds: High-risk, high-yield bonds, also known as non-investment-grade bonds.
• Convertible Bonds: Can be converted into common stock.
• Fixed-Rate Bonds: Consistent interest rates.
• Zero-Interest-Rate Bonds: No regular interest payments.
• Perpetual Bonds: No maturity date.
• Bearer Bonds: No record of the bondholder.
• War Bonds: Issued during wartime.

Capital

• Fixed Capital: Long-term assets used in business, like buildings.
• Working Capital: Short-term assets used in business operations, like cash or inventory.

Cash Management System

• A system for managing cash transactions within a company.
• Facilitates complete analysis, forecasts, and reporting.

Inventory Management System

• Inventory control system that includes raw materials, work in progress, and finished goods.

Importance of Funding

• Meeting business obligations and capital requirements.
• Implementation of business initiatives (projects & campaigns).

Short-Term Funding Sources

• Indigenous Bankers, Trade Credit, Installment Credit, Advances, Factoring, Deferred Income, Commercial Paper, and Overdrafts.

Long-Term Funding Sources

• Equity loans from government and loans from public finance institutions.
• Public deposits (e.g., deposits with a corporation or firm).

Money Market Functions

• Provides short-term liquidity to governments, banks, and other organizations.
• Allows investors with excess funds to earn interest.

This quiz explores the concepts of risk and return in investments, emphasizing the relationship between them and how diversification can help mitigate risk. It covers systematic and unsystematic risk and provides an overview of their implications for investors.