Chapter 12 · 7 of 100 marks · workbook pages 228-246
Fundamentals of Risk and Return
Return measures (simple, annualised, CAGR), the risk types, standard deviation and beta, sensitivity and margin of safety, equity versus bonds, Sharpe, Treynor and Jensen, behavioural biases and liquidity.
Focus
- Return calculations
- Risk types
- Standard deviation
- Beta
- Sensitivity
- Margin of safety
- Risk-adjusted return
- Biases
- Liquidity
Must know
- Return can be simple, annualized, or compounded depending on holding period and reinvestment assumptions.
- Risk is uncertainty in outcome; beta measures sensitivity to market movements.
- Margin of safety is the gap between intrinsic value and purchase price.
- Liquidity of equity shares can be assessed through volume, bid-ask spread, impact cost, and trading frequency.
Traps
- Higher return without risk context is incomplete.
- Beta measures market risk, not business quality.
- Compounded return differs from average simple return.
Formulas in this chapter
Full sheet- Holding Period Return (HPR): HPR = (Ending value - Beginning value + Income) / Beginning value
- CAGR: CAGR = (Ending value / Beginning value)^(1 / years) - 1
- Expected Return: Expected return = Sum of (Probability x Outcome)
- Sharpe Ratio: Sharpe = (Portfolio return - Risk-free rate) / Standard deviation