Risk return relationship, Financial Management

RISK RETURN RELATIONSHIP

A business operates in a market environment, which is not within its control. It is exposed to several dangers from the internal with external sources or factors. It may result in the incapability of the firm to withstand its competitors; its products or services may deteriorate, or become obsolete in the market.  It is the duty of the finance manager to maintain all internal and external risks at the smallest and prepare the firm to face all the challenges resulting in higher shareholder wealth maximization.

Risk and return concepts are fundamental to the catching of the valuation of assets or securities. Risk may be described as 'the chance of future loss that can before- seen' implying that the extent of loss can be estimated.  This is generally done by assigning probabilities to the risk on the basis of past data and the probable trends. Risk refers to the variability of expected returns related with a given security or asset.  Return on an asset includes capital gain and dividend yield.  The expected rate of return on a security is the total of the products of possible rates of return and their probabilities. The rate of return to a great extent depends on the

Risk involved. The relationship of return and risk are - higher the risk, higher is the return.  It is also the duty of the finance manager to take all decisions which will result in shareholder wealth maximization.  The word 'return' has been explained in several ways by several people.

The two main concerns of an investor while choosing a  asset are the expected return from holding the asset and the risk that the actual return may be below the expected return.

The rate of return required by a business consists of three components - return at premium of business risk (business risk refers to the variability of operating profit due to changes in sales) which is the return expected by the shareholders for facing the higher risk involved, zero risk (it refers to the expected return when the risk level - business risk or financial risk, is zero) and premium for financial risk (financial risk refers to the risk on account of pattern of capital structure - that is., debt and equity mix) which represents the return expected by the share holders for the higher financial risk they are facing.

The most general and popular approaches (behavioral) to assess risk are -

 Probability distribution and Sensitivity analysis.  Some of the most popular statistical measures of variability of returns include - standard deviation and coefficient of variation.

The relationship between return and risk can be described by the equation

Return = Risk free rate + Risk premium

Posted Date: 10/15/2012 8:51:45 AM | Location : United States







Related Discussions:- Risk return relationship, Assignment Help, Ask Question on Risk return relationship, Get Answer, Expert's Help, Risk return relationship Discussions

Write discussion on Risk return relationship
Your posts are moderated
Related Questions
Q. What do you understand by Business cycle? Business cycle: business cycle refers to the alternate expansion and contraction in the general business activity. in a period of t

Preparing the Divestiture No two divestitures are exactly alike and one of the foremost tasks of the project team is to determine precisely what is to be sold. While some dives

Demand and Supply Shocks The influence of the above macroeconomic factors on the economic performance can be analyzed by classifying their impact on the economy as a supply or

You are considering starting a walk-in-clinic. Your financial projections for the first year of operation are as follows: Revenues (10,000 visits) $400,000 Wages and benefits $220,

Define the meaning of objective - financial management The term objectives offers a normative framework. That is the focus in financial literature is on what a firm must try to

Explain the difference between performing the capital budgeting analysis from the parent firm’s perspective as opposed to the project perspective. The aim of the financial mana

AGENCY THEORY An agency relationship may be defined as a contract under which one or more people (the principals) hire another person (the agent) to perform some services on th

Considerations for the financiers of MBOs Support of MBO will rely on various factors: The reason for sale of business. Is it falling on hard times? Is group divesting to co

Reston, Inc., has asked your corporation, Pruro, Inc., for financial assistance. As a long-time customer of Reston, your firm has decided to give that assistance. The question you

Alternative summarised version of tests of controls · Segregation of duty (staff records are separate from wages department) · Documentation ( written evidence ) ·