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Types of Risk

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A typical one measures a stock's risk ratio, or how much the investment might increase in value versus how much it might fall.
For example, a stock with a share price of $50 that analysts predict could go to $80 (a $30 gain), but could potentially fall to $40 (a $10 loss), has a risk ratio of 3:1, or $30 up/$10 down. Similarly, if the stock might rise only $5 but could fall $25, its risk ratio is 1:5, and it's a much more risky investment

 

 

 

 

 

 

Standard deviation is probably used more than any other measure to describe the risk of a security (or portfolio of securities).Standard deviation is one of the most commonly used statistical tools in the sciences and social sciences. It provides a precise measure of the amount of variation in any group of numbers.

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Beta, ß, is a measure of market risk: the greater the beta, the more sensitive are the returns on the stock to changes in the returns on the market. Beta is fairly easy to interpret. A beta that is greater than one means that the fund or stock is more volatile than the benchmark index, while a beta of less than one means that the security is less volatile than the index. The biggest drawback of Beta is that is that it's really only useful when calculated against a relevant benchmark.

ß=CORRS,SP500SDSSDSP500 (divided by) (SDSP500)^2

 

The beta of a portfolio is the weighted average of the betas of the securities in the portfolio, where the weights are the proportion of the portfolio invested in the asset.

ßp = (sum of) wi ßi

 

The capital asset pricing model (CAPM) is based on a theory that states that the expected return on an asset is the sum of the return on a risk-free asset and the return commensurate with the asset's market risk. If you use CAPM you have to assume that most investors want to avoid risk, (risk averse), and those who do take risks, expect to be rewarded.

R(rs)= rf+ß(E(rm)-rf)

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