Category Archives: RISK AND RETURN


SUMMARY > Risk refers to the variability of expected returns associated with a given security or asset. > The absolute return on an investment for a given period of time; say a year, consists of annual income plus change in the market price of the investment (capital appreciation or loss); total annual income (loss) in terms of the rate of return is expressed as a percentage of the opening market value of

Multifactor Linear Model (Example)

EXAMPLE Suppose the riskless return is 5 per cent and the market portfolio's expected return (r,) is 11 per cent. Assume further that beta coefficients for security 1.3 (in relation to market portfolio, (in relation to growth rate of GOP) and (in relation to inflation), The expected growth rate in GOP is 8 per cent and inflation is 3 percent  / Determine the expected return of security i. Though the APT is in


FACTORS It may be emphasised here that the APT framework normally includes the market risk premium (return on the market portfolio minus risk free rate) as one of the factors; it may be recapitulated that market risk premium is the sole factor used in the CAPM. The other factors included are macroeconomic and firm specific, while the major macroeconomic factors are inflation, interest rates, growth rate in gros

Multifactor Linear Model

Multifactor Linear Model Another useful way of explaining the APT is that it relates the returns of security within a multivariate framework in which the return relationships arc linear. Multivariate framework implies that there are a variety of different factors which influence security returns. However. the theory does not specify these factors on the basis of conceptual argument. The argument presumably is t


ARBITRAGE PRICING THEORY Although CAPM approach has been widely accepted as a determinant of required return .of a security (asset). it is beset with a number of restrictive assumptions affecting its application in practice. For instance, the CAPM framework assumes that there exists a market portfolio consisting of all risky assets. Apart from the unobservable asset of such a portfolio, the portfolio itself may

After-tax Return from Securities of Companies X and Y (Table)

After-tax Return from Securities of Companies X and Y TABLE After-tax Return from Securities of Companies X and Y It is apparent from Table 3.7 that in spite of the lower expected return before taxes (14.5%) of company Y, its expected after-lax return is higher on account of the fact that a higher proportion of income/return consists of capital gains. Evidently, the tax-paying investor prefers securities of co

Taxes (Example)

EXAMPLE Suppose the investor is expected to have return of 10 per cent (consisting of a dividend 10 per cent and 10  per cent capital gain on initial value) by holding securities in Company X. Company Y is expected to provide dividend yield of 11 per cent and capital appreciation of 10 per cent of 14. per cent . Assume further that dividend income is taxed at 30 per cent and capital Rain at 20 per cent. These be


EXTENDED CAPM The CAPM is essentially a single-factor model in that the security’s expected return depends on a single factor, namely, beta. But there may be other factors. apart from beta, which may affect required returns. Therefore, the inclusion of these factors in the CAPM equation would provide better explanation of the variables impacting security returns. The major factors are: (i) taxes. (ii) inf


Taxes The investor receives return on security in the form of dividend income and capital gains or losses. Accordingly. the lax liability of the investor is of two types: (i) tax on dividend income and (ii) tax on capital gains.  When both the types of income arts either free-of-tax or the are taxed at the same the CAPL results hold true whether company pay more or less dividends. However, i'n practice, capita

Validity of the CAPM

Validity of the CAPM The capital asset pricing model is a rigorously derived equilibrium model. Like any other economic model, it is an abstraction and simplification of reality. It has been widely used and hailed. Its popularity may be ascribed to a set of four factors. First, the risk-return trade-off-s-the direct proportional relationship between the two-has a distinct -intuitive appeal. Second, transition fr