(92)---RISK OF RATES OF RETURN

Risk of Rates of Return

The variability of rates of return may be defined as the extent of the deviations or dispersion of individual rates of return from the average rate of return. There are two measures of this dispersion, variance or standard deviation.

The following steps are involved in calculating variance or standard deviation of rates of return of assets or securities using historical returns,

• Calculate the average rate of return.
• Calculate the deviation of individual rates of return from the average rate of return and square.
• Calculate the sum of the square of the deviations as determined in the preceding step and divide it by the number of periods or observations less one to obtain variance.
• Calculate the square root of the variance to determine the standard deviation.

(91)---RISK AND RETURN

Risk and Return

Risk and return are most important concepts in finance. In fact, they are the foundation of the modern finance theory.

What is the risk? How is it measured? What is return? How is it measured? How are assets valued in capital markets? How do investors make their investment decisions? We are going to discuss these questions in our future posts.

Return on a single asset

Total return = Dividend + Capital gain

Unrealized capital gain or loss

If an investor holds a share and does not sell it at the end of the period, the difference between the beginning and ending share prices is the unrealized capital gain or loss.
The investor must consider the unrealized capital gain or loss as part of his total return. The fact of the matter is that if the investor so wanted, he could have sold the share and realized the capital gain or loss.