k|sk and keturn

SecurlLy analysls ls bullL around Lhe ldea LhaL lnvesLors are concerned wlLh Lwo
prlnclpal properLles lnherenL ln securlLles Lhe reLurn LhaL can be expecLed from
Poldlng a securlLy and Lhe rlsk LhaL Lhe reLurn LhaL ls achleved wlll be less Lhan
Lhe reLurn LhaL was expecLed
Secur|ty keturns 8eLurn ls Lhe moLlvaLlng force and Lhe prlnclpal reward ln Lhe
lnvesLmenL process and lL ls Lhe key meLhod avallable Lo lnvesLors ln comparlng
alLernaLlve lnvesLmenLs
kea||zed keturn 8eallzed reLurn ls afLer Lhe facL reLurn reLurn LhaL was earned
(or could have been earned) 8eallzed reLurn ls hlsLory
Lxpected keturn LxpecLed reLurn ls Lhe reLurn from an asseL LhaL lnvesLors
AnLlclpaLe Lhey wlll earn over some fuLure perlod lL may or may noL occur
lnvesLors should be wllllng Lo purchase a parLlcular asseL lf Lhe expecLed reLurn
ls adequaLe
L|ements |n keturn 8eLurn on a Lyplcal lnvesLmenL conslsLs of Lwo componenLs
1he baslc componenL ls Lhe perlodlc cash recelpLs(or lncome) on Lhe lnvesLmenL
LlLher ln Lhe form of lnLeresL or dlvldends 1he second componenL ls Lhe change
ln Lhe prlce of Lhe asseL commonly called Lhe caplLal galn or loss
1hls elemenL of reLurn ls Lhe dlfference beLween Lhe purchase prlce and Lhe
prlce aL whlch Lhe asseL can be or ls sold Lherefore lL can be a galn or a loss
1ota| return Income + r|ce change (+])
keturn Measurement
1ota| keturn Cash payments rece|ved + r|ce change over the per|od

urchase pr|ce of the asset
k|sk 8lsk ln holdlng securlLles ls generally assoclaLed wlLh Lhe posslblllLy LhaL
8eallzed reLurns wlll be less Lhan Lhe reLurns LhaL were expecLed
lorces LhaL conLrlbuLe Lo varlaLlons ln reLurn prlce or dlvldend(lnLeresL) consLlLuLes
LlemenLs of rlsk Some lnfluences are exLernal Lo Lhe flrm cannoL be conLrolled and
AffecL large numbers of securlLles
ln lnvesLmenLs Lhose forces LhaL are unconLrollable exLernal and broad ln Lhelr
LffecL are called sources of sysLemaLlc rlsk Conversely conLrollable lnLernal
lacLors somewhaL pecullar Lo lndusLrles and/or flrms are referred Lo as sources
Cf unsysLemaLlc rlsk
SysLemaLlc rlsk refers Lo LhaL porLlon of LoLal varlablllLy ln reLurn caused by facLors
AffecLlng Lhe prlces of all securlLles Lconomlc pollLlcal and soclologlcal changes
Are sources of sysLemaLlc rlsk
1helr effecL ls Lo cause prlces of nearly all lndlvldual common sLocks and/or all
lndlvldual bonds Lo move LogeLher ln Lhe same manner
Systemat|c k|sk
Market k|sk 1he change ln lnvesLor's aLLlLudes Loward equlLles ln general or
1oward cerLaln Lypes or groups of securlLles ln parLlcular varlablllLy ln reLurn on
mosL common sLocks LhaL ls due Lo baslc sweeplng changes ln lnvesLor expecLaLlons
ls referred Lo as markeL rlsk
1wo oLher facLors lnLeresL raLes and lnflaLlon are an lnLegral parL of Lhe real forces
8ehlnd markeL rlsk and are parL of Lhe larger caLegory of sysLemaLlc or
unconLrollable lnfluences
Interest kate k|sk lnLeresLraLe rlsk refers Lo Lhe uncerLalnLy of fuLure markeL
values and Lhe slze of fuLure lncome caused by flucLuaLlons ln Lhe general
Level of lnLeresL raLes
1he rooL cause of lnLeresLraLe rlsk lles ln Lhe facL LhaL as Lhe raLe of lnLeresL pald
on uS governmenL securlLles rlses or falls Lhe raLe of reLurn demanded on
alLernaLlve lnvesLmenL vehlcles such as sLocks and bonds lssued ln Lhe prlvaLe secLor
rlse or fall ln oLher words as Lhe cosL of money changes for nearly rlskfree
SecurlLles Lhe cosL of money Lo more rlskprone lssuers wlll also change
urchas|ngower k|sk urchaslng power rlsk ls Lhe uncerLalnLy of Lhe purchaslng
ower of Lhe amounLs Lo be recelved ln more everyday Lerms purchaslng power
8lsk refers Lo Lhe lmpacL of lnflaLlon or deflaLlon
lf we Lhlnk of lnvesLmenL as Lhe posLponemenL of consumpLlon we can see LhaL
When a person purchases a sLock he has foregone Lhe opporLunlLy Lo buy some
Cood or servlce for as long as he owns Lhe sLock lf durlng Lhe holdlng perlod
rlces on deslred goods and servlces are normally assoclaLed wlLh whaL ls
8eferred Lo as lnflaLlon
Interest kate k|sk lnLeresLraLe rlsk refers Lo Lhe uncerLalnLy of fuLure markeL
values and Lhe slze of fuLure lncome caused by flucLuaLlons ln Lhe general
Level of lnLeresL raLes
1he rooL cause of lnLeresLraLe rlsk lles ln Lhe facL LhaL as Lhe raLe of lnLeresL pald
on uS governmenL securlLles rlses or falls Lhe raLe of reLurn demanded on
alLernaLlve lnvesLmenL vehlcles such as sLocks and bonds lssued ln Lhe prlvaLe secLor
rlse or fall ln oLher words as Lhe cosL of money changes for nearly rlskfree
SecurlLles Lhe cosL of money Lo more rlskprone lssuers wlll also change
urchas|ngower k|sk urchaslng power rlsk ls Lhe uncerLalnLy of Lhe purchaslng
ower of Lhe amounLs Lo be recelved ln more everyday Lerms purchaslng power
8lsk refers Lo Lhe lmpacL of lnflaLlon or deflaLlon
lf we Lhlnk of lnvesLmenL as Lhe posLponemenL of consumpLlon we can see LhaL
When a person purchases a sLock he has foregone Lhe opporLunlLy Lo buy some
Cood or servlce for as long as he owns Lhe sLock lf durlng Lhe holdlng perlod
rlces on deslred goods and servlces are normally assoclaLed wlLh whaL ls
8eferred Lo as lnflaLlon
|nanc|a| r|sk
llnanclal rlsk ls assoclaLed wlLh Lhe way ln whlch a company flnances lLs
AcLlvlLles We usually gauge flnanclal rlsk by looklng aL Lhe caplLal sLrucLure of a
flrm 1he presence of borrowed money or debL ln Lhe caplLal sLrucLure creaLes
flxed paymenLs ln Lhe form of lnLeresL LhaL musL be susLalned by Lhe flrm
1he presence of Lhese lnLeresL commlLmenLsflxed lnLeresL paymenLs due Lo debL
or flxed dlvldend paymenLs on preferred sLock causes Lhe amounL of resldual
earnlngs avallable for common sLock dlvldends Lo be more varlable Lhan lf no
lnLeresL paymenLs were requlred
llnanclal rlsk ls avoldable rlsk Lo Lhe exLenL LhaL managemenLs have Lhe freedom
Lo declde Lo borrow or noL Lo borrow funds A flrm wlLh no debL flnanclng
has no flnanclal rlsk
Speclflcally Lhe rellance on debL flnanclng called flnanclal leverage has aL leasL Lhree
lmporLanL effecLs on commonsLock holders uebL flnanclng 1) lncreases Lhe varlablllLy
of Lhelr reLurns 2) affecLs Lhelr expecLaLlons concernlng Lhelr reLurns and 3) lncreases
Lhelr rlsk of belng rulned