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In the world of finance, every investment decision involves a trade-off between risk and return. Understanding this relationship is crucial for aspiring commerce professionals, especially those preparing for UGC NET Paper 2 Commerce. Risk and return analysis is a core part of the syllabus under Unit – Business Finance, and mastering this topic can give you a solid edge in both conceptual and numerical sections of the exam.

What is Return?

Return refers to the gain or loss an investor earns from an investment over a specified period. It is usually expressed as a percentage.

Formula:
Return (%) = Income+(Ending Price – Beginning Price)Beginning Price×100

Types of Returns:

• Actual (Realized) Return: The return actually earned
• Expected Return: The return that an investor anticipates or forecasts

Expected Return (ER):
ER = ∑(��×��)
Where �� = possible return, and �� = probability of return

What is Risk?

Risk refers to the uncertainty or variability of returns from an investment. It is the possibility that the actual return may differ from the expected return.

Standard Deviation and Variance are commonly used to measure risk.

Types of Risk:

1. Systematic Risk

• Also known as market risk
• Affects the entire market
• Examples: Inflation, interest rate changes, recession
• Cannot be diversified

2. Unsystematic Risk

• Also known as specific or company risk
• Affects a specific company or industry
• Examples: Labour strikes, management changes
• Can be diversified through a well-diversified portfolio

Risk-Return Trade-off

This principle states that higher the risk, higher the potential return and vice versa. Investors must balance their risk tolerance with their return expectations. Conservative investors prefer low-risk, low-return investments, while aggressive investors seek high-risk, high-return opportunities.

Measurement of Risk and Return

1. Return Measures

• Expected Return: Weighted average of possible returns
• Holding Period Return (HPR): Return over a single holding period

2. Risk Measures

• Standard Deviation (σ): Measures total risk (volatility)
• Variance (σ²): Square of standard deviation
• Beta (β): Measures systematic risk relative to the market

Beta Interpretation:

• β = 1: Same risk as market
• β > 1: More volatile than market
• β < 1: Less volatile than market

Capital Asset Pricing Model (CAPM)

CAPM is used to determine the expected return on an asset based on its risk.

Formula:
�(��)=��+��(��−��)

Where:

• �(��): Expected return of the investment
• ��: Risk-free rate
• ��: Beta of the security
• ��: Expected return of the market

Portfolio Risk and Return

When combining assets into a portfolio:

• Portfolio Return:
  ��=�1�1+�2�2+...+����
  Where � = weights of each asset, � = individual asset returns
• Portfolio Risk (Two Assets):
  ��2=�12�12+�22�22+2�1�2�1�2�12

Where:
��: Portfolio standard deviation
�12: Correlation coefficient between assets

Sample UGC NET MCQ on Risk and Return

Q: If a security has a beta of 1.2, a risk-free rate of 6%, and the expected market return is 12%, what is the expected return as per CAPM?

A) 13.2%
B) 14.4%
C) 12.0%
D) 11.2%

Answer:
E(R) = 6% + 1.2(12% – 6%) = 6% + 7.2% = 13.2%
Correct Option: A

Tips for UGC NET Preparation

• Understand concepts like systematic vs. unsystematic risk, beta, and CAPM.
• Practice numericals involving expected return, standard deviation, and portfolio risk.
• Revise formulas regularly and solve previous year papers.
• Focus on applications of risk-return in portfolio decisions and investment analysis.

Conclusion

Risk and Return Analysis is not just a theoretical topic—it lies at the heart of all investment decisions. Whether you're preparing for UGC NET or managing real-world portfolios, a sound understanding of how risk affects return is essential. Strengthen your preparation by combining theory with practical application and stay exam-ready.

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