1.

1 INTRODUCTION

The risk/return relationship is a fundamental concept in not only financial analysis, but in
every aspect of life. If decisions are to lead to benefit maximization, it is necessary that
individuals/institutions consider the combined influence on expected (future) return or
benefit as well as on risk/cost. Return expresses the amount which an investor actually
earned on an investment during a certain period. Return includes the interest, dividend and
capital gains; while risk represents the uncertainty associated with a particular task. In
financial terms, risk is the chance or probability that a certain investment may or may not
deliver the actual/expected returns.
The risk and return trade off says that the potential return rises with an increase in risk. It
is important for an investor to decide on a balance between the desire for the lowest
possible risk and highest possible return.
RISK & RETURN:

Investment decisions are influenced by various motives. Some people invest in a

business to acquire control & enjoy the prestige associated with in. some people invest
in expensive yachts & famous villas to display their wealth. Most investors, however,
are largely guided by the pecuniary motive of earning a return on their investment. For
earning returns investors have to almost invariably bear some risk. In general, risk &
return go hand in hand.
Sometimes the best investments are the ones you don't make. This is a maxim
which best explains the complexity of making investments. There are many
investment avenues available for investors today.
Different people have different motives for investing. For most investors their
interest in investment is an expectation of some positive rate of return. But investors
cannot overlook the fact that risk is inherent in any investment. Risk varies with the
nature of return commitment. Generally, investment in equity is considered to be more
risky than investment in debentures & bonds. A closer look at risk reveals that some
are uncontrollable (systematic risk) and some are controllable (unsystematic risk).

1
RETURN:
Return is the primary motivating force that drives investment. It represents the
reward for undertaking investment. Since the game of investing is about returns (after
allowing for risk), measurement of realized (historical) returns is necessary to assess
how well the investment manager has done.
In addition, historical returns are often used as an important input in estimating
future prospective returns.

Components of Return:
The return of an investment consists of two components.

Current Return:
The first component that often comes to mind when one is thinking about
return is the periodic cash flow, such as dividend or interest, generated by the
investment. Current return is measured as the periodic income in relation to the
beginning price of the investment.

Capital Return:
The second component of return is reflected in the price change called the
capital return- it is simply the price appreciation (or depreciation) divided by the
beginning price of the asset. For assets like equity stocks, the capital return
predominates.Thus, the total return for any security (or for that matter any asset) is
defined as:

Total Return = Current return + Capital return

The current return can be zero or positive, whereas the capital return can be
negative, zero, or positive.

2
RISK AND RETURN ANALYSIS

RISK:

Investor cannot talk about investment returns without talking about risk
because investment decisions invariably involve a trade-off between the risk & return.
Risk refers to the possibility that the actual outcome of an investment will differ from
its expected outcome.

More specifically, most investors are concerned about the actual outcome
being less than the expected outcome. The wider range of possible outcomes, the
greater the risk. Investments have two components that create risk. Risks specific to a
particular type of investment, company, or business are known as unsystematic risks.
Unsystematic risks can be managed through portfolio diversification, which consists
of making investments in a variety of companies & industries. Diversification reduces
unsystematic risks because the prices of individual securities do not move exactly
together. Increases in value & decreases in value of different securities tend to cancel
one another out, reducing volatility. Because unsystematic risk can be eliminated by
use of a diversified portfolio, investors are not compensated for this risk.
Systematic risks, also known as market risk, exist because there are systematic
risks within the economy that affect all businesses. These risks cause stocks to tend to
move together, which is why investors are exposed to them no matter how many
different companies they own.
Investors who are unwilling to accept systematic risks have two options. First,
they can opt for a risk-free investment, but they will receive a lower level of return.
Higher returns are available to investors who are willing to assume systematic risk.
However, they must ensure that they are being adequately compensated for this risk.
The Capital Asset Pricing Model theory formalizes this by stating that companies
desire their projects to have rates of return that exceed the risk- free rate to
compensate them for systematic risks & that companies desire larger returns when
systematic risks are greater. The other alternative is to hedge against systematic risk
by paying another entity to assume that risk. A perfect hedge can reduce risk to
nothing except for the costs of the hedge.

3
 The market tends to move in cycles. A John Train says:
“You need to get deeply into your bones the sense that any market, & certainly
the stock market, moves in cycles, so that you will infallibly get wonderful bargains
every few years, & have a chance to sell again at ridiculously high prices a few years
later.”

Systematic Risk:

There is some risk, called systemic risk that you can't control. But if you learn
to accept risk as a normal part of investing, you can develop asset allocation and
diversification strategies to help ease the impact of these situations. And knowing how
to tolerate risk and avoid panic selling is part of a smart investment plan. The
systematic risk is caused by the factors external to the particular company and
uncontrollable by the company. These are market risks that cannot be diversified
away. Interest rates, recessions & wars are examples of systematic risk.
The systematic risk is further subdivided into three types.
1. Market risk
2. Interest rate risk
3. Purchasing power risk

1. Market Risk:
This is the possibility that the financial markets will drop in value and create a
ripple effect in your portfolio. For example, if the stock market as a whole loses value,
chances are your stocks or stock funds will decrease in value as well until the market
returns to a period of growth. Market risk exposes you to potential loss of principal,
since some companies don't survive market downturns. But the greater threat is the
loss of principal that can result from selling when prices are low.

2. Interest rate risk:

This is the possibility that interest rates will go up. If that happens, inflation
increases, and the value of existing bonds and other fixed-income investments
declines, since they're worth less to investors than newly issued bonds paying a higher
rate. Rising interest rates also usually mean lower stock prices, since investors put

4
 more money into interest-paying investments because they can get a strong return with
less risk.

3. Purchasing power risk:

Variations in the return are caused also by the loss of the purchasing power of
currency. Inflation is the reason behind the loss of the purchasing power. Purchasing
power risk is probable loss in the purchasing power of returns to be received.

Inflation may be demand pull or cost push inflation. On demand pull inflation
the demand for goods and services are in excess of their supply. At full employment
level of factors of production, economy would not be able to supply more goods in
short run and the demand for the products pushes the price upwards. The equilibrium
between the demand and the supply is attained at the higher price.

The cost push inflation as the name itself indicates that the inflation or the
raise in the price is caused by the increase in the cost. The increase in the cost of raw
material, labour and equipment makes the cost of production high and ends in high
price level. Thus the cost inflation has a spiraling effect on the price level.

Unsystematic Risk:
It is unique and peculiar to the firm or an industry. Unsystematic risk stems
from managerial inefficiency, technological change in the production process,
availability of the raw materials, changes in consumers preferences and labour
problems. The unsystematic risk can be classified into two types.
1. Business Risk 2. Financial Risk

1. Business Risk:
It is that portion of unsystematic risk caused by operating environment of the
business. Business risk arises from the inability of the firm to maintain its competitive
edge and the growth of the stability of the earning variation that occurs in the
operating environment is reflected in the operating income and expected dividends. It
indicates business risk. Business risk is any risk that can lower a business’s net assets
or net income that could, in turn, lower the return of any security based on it. Some
business risks are sector risks that can affect every company in a particular sector,
while some business risks affect only a particular company.
5
2. Financial Risk:
It refers to the variability of the income to the equity capital due to debt
capital. Financial risk in a company is associated with the capital structure of the
company. Capital structure of the company consists of equity funds and borrowed
funds. The presence of debt and preference capital results in commitment of paying
interest or prefixed rate of dividend.

This arises due to changes in the capital structure of the company. It is also
known as leveraged risk and expressed in the terms of debt-equity ratio. Excess of
debt over equity in the capital structure of a company indicates that the company is
highly geared even if the per capital earnings of such company may be more. Because
of highly dependence on borrowings exposes to the risk of winding up for its inability
to honour its commitments towards lenders and creditors. So the investors should be
aware of this risk and portfolio manager should also be very careful.

3. Regulation Risk:

Some investment can be relatively attractive to other investments because of

certain regulations or tax laws that give them an advantage of some kind. Municipal
bonds, for example pay interest that is exempt from local, state and federal taxation.
As a result of that special tax exemption, municipal can price bonds to yield a lower
interest rate since the net after-tax yield may still make them attractive to investors.
The risk of a regulatory change that could adversely affect the stature of an investment
is a real danger. In 1987, tax laws changes dramatically lessened the attractiveness of
many existing limited partnership that relied upon special tax considerations as part of
their total return. Prices for many limited partnership tumbled when investors were
left with different securities, in effect, than what they originally bargained for. To
make matter worse, there was not an extensive secondary market for these liquid
securities and many investors found themselves unable to sell those securities at
anything but “fire sale” prices if at all.

6
 1.2 NEED FOR THE STUDY

In the finance field, it is a common knowledge that money or finance is scarce and that
investors try to maximize their returns. But when the return is higher, the risk is also
higher. Return and risk go together and they have a tradeoff. The art of investment is to
see that return is maximized with minimum risk.
In the above discussion we concentrated on the word “investment” and to invest we need
to analyze securities. Combination of securities with different risk-return characteristics
will constitute the portfolio of the investor.

7
 1.3 SCOPE OF THE STUDY

The study covers all the information related to the investor risk-return relationship of gold
and silver. It is confined to five years data of gold and silver securities. It also includes the
calculation of individual standard deviations which helps in allocating the funds available
for investment based on risky portfolios.

1.4 OBJECTIVES OF THE STUDY

1. To study the fluctuations in share prices of GOLD AND SILVER selected companies.
2. To study the risk involved in the GOLD AND SILVER of selected companies.
3. To make comparative study of risk and return of GOLD AND SILVER.
4. To study the systematic risk involved in the selected GOLD AND SILVER.
5. To offer some suggestions to the investors.

8
 1.5 METHODOLOGY OF THE STUDY

The data used in this project is of secondary nature. The data is collected from secondary
sources such as various websites, journals, newspapers, books, etc., the analysis used in
this project has been done using selective technical tools. In Equity market, risk is
analyzed and trading decisions are taken on basis of technical analysis. It is collection of
share prices of selected companies for a period of five years.

This is the study of Risk-Return analysis for a period of five years (2013-18).

2.5 Methodology Adopted Research methodology is the route used to systematically

resolve the research problem. It is a scientific way of studying how research is done
scientifically, approved by the researcher in reviewing the research problem alongside
with the reason behind study. It is essential for the researcher to distinguish not only the
research methods and procedures but also the methodology.

Sample size:
The sample consists of one commodity – from MCX market, on the basis of the
research objectives. This study is mainly based on the Gold prices in Indian commodity
market.
Data Collection
The research is purely based on secondary data.
Secondary Data
Secondary data was collected by referring to following sources:
1. Alpha Commodities Private Ltd Online publication.
2. BSE websites
3. Text books
4. Research Journals Study Period The study includes a period of
5 years from 2013-2018.

9
 1.6 LIMITATIONS

This study has been conducted purely to understand Risk-return characteristics for investors.
The study is restricted to only two selected companies.
Very few and randomly selected scripts/companies are analyzed from BSE listings The study
is limited to GOLD AND SILVER only.

10