Presentation by:Rida Mazhar (Roll no: 24)

Muhammad Haris Shakeel (Roll no:19)

Muhammad Jahangir Khan(Roll no: 20)

RISK AND UNCERTAINTY

By: Rida Mazhar

Similarities Between Risk and Uncertainty

Based on current lack of certainty in a potential fact, event, outcome etc.

Defined by probabilities or probabilities distributions.

Include both upside and downside potential.

Depend on “who knows what”

Differences between Risk and Uncertainty

RISK UNCERTAINTY

1. On the basis of past relevant experience , assign probabilities to

outcomes.

1. On the basis of little past experience, thus

difficult to assign probabilities to

outcomes.

2. Risk increases the variability of returns

increases.

2. Uncertainty increases as project life increases.

RISKIt exists when the

decision maker knows the various outcomes

but also the probability associated

with each potential outcome.

UNCERTAINTYIt exists when a

decision maker knows all potential future

outcomes of a certain act but for one reason

or another cannot assign probabilities to the various outcomes.

RISK AND UNCERTAINTY IN FINANCEThe uncertainty associated with returns

that reduces risk into an investment.Risk is a quantifiable uncertainty.Risk may be due to environmental or managerial factors.From conception or identification to implementation, risks issue arise and do affect the projects in a number of ways.

Why Manage Risks?

Save resources: People, income, property, assets, time.

Protects public image.

Protects people from harm.

Prevents/reduce the legal ability.

Protects the environment.

Forms of Risk and Uncertainty

Discrete

Continuous

Complex

Risk and Uncertain Measures

Risk and uncertainty are based on lack of uncertainty in a potential in a potential fact, event, or outcome.

Uncertainty is measured relative to expected value.

Risk is measured relative to a set target with potential consequences that matter.

They can be measured in many ways, but the best measures are based on probability-weighted average deviation in value, corresponding to areas under a CDF curve.

SYSTEMATIC RISK

By: Muhammad Haris Shakeel

The risk inherent to the entire market or entire market segment. 

Also known as "un-diversifiable risk" or "market risk."

Interest rates, recession and wars all represent sources of systematic risk because they affect the entire market

Cannot be avoided through diversification

This type of risk affects a broad range of securities

Systematic risk can be mitigated only by being hedged. 

SYSTEMATIC RISK

INTEREST RATE RISK

Interest-rate risk arises due to variability in the interest rates from time to time. It particularly affects

debt securities as they carry the fixed rate of interest

INTEREST RATE RISK

PRICE RISKPrice risk arises due to the possibility that

the price of the shares, commodity, investment, etc. may decline or fall in the future.

RE-INVESTMENT RISKRe-investment rate risk results from fact that the interest or dividend earned from an investment can't be reinvested with the same rate of return as it was acquiring earlier.

MARKET RISK

Market risk is associated with consistent fluctuations seen in the trading price of any particular shares or securities. That is, it arises due to rise or fall in the trading price of listed shares or securities in the stock market.

MARKET RISK

ABSOLUTE RISKAbsolute risk is without any content.

RELATIVE RISKRelative risk is the assessment or evaluation

of risk at different levels of business functions.

DIRECTIONAL RISKDirectional risks are those risks where the

loss arises from an exposure to the particular assets of a market.

MARKET RISK

NON-DIRECTIONAL RISKNon-Directional risk arises where the method of trading is not consistently followed by the trader.

BASIS RISKBasis risk is due to the possibility of loss arising from imperfectly matched risks.

VOLATILITY RISKVolatility risk is of a change in the price of securities as a result of changes in the volatility of a risk-factor.

PURCHASING POWER RISKOR

INFLATIONARY RISK

Purchasing power risk is also known as inflation risk. It is so, since it emanates (originates) from the fact that it affects a purchasing power adversely. It is not desirable to invest in securities during an inflationary period.

PURCHASING POWER RISKOR

INFLATIONARY RISK

PURCHASING POWER RISK

DEMAND INFLATION RISKDemand inflation risk arises due to increase in price, which result from an excess of demand over supply. It occurs when supply fails to cope with the demand and hence cannot expand anymore. In other words, demand inflation occurs when production factors are under maximum utilization.

COST INFLATION RISKCost inflation risk arises due to sustained increase in the prices of goods and services. It is actually caused by higher production cost. A high cost of production inflates the final price of finished goods consumed by people.

Unsystematic Risk and Return

By: Muhammad Jahangir Khan

Capital Asset Pricing Model (CAPM)

Calculate a cost of equity and incorporates risk.

Based on a comparison of systematic.

CAPM Formula

E(ri) = Cost of equityRf = Risk-free rate of return

E(rm) =Market returnβ = Beta factor of individual security

E(ri) = Rf + β [E(rm) – Rf]

Problems with applying the CAPM

1.Need to determine the excess return [E(rm) – Rf]

2.Need to determine risk-free rate.

3.Errors in the calculation of β values. As it change overtime.

RETURN

1. Market Return

2. Risk-free Return

Excess Return

QUESTIONS