Portfolio Management

To make the most of one’s investment portfolio investors must participate

actively in portfolio management. By doing so, they will not only be able to
cushion their resources against market risks but will also be able to maximise
their returns successfully.
What is Portfolio Management?
Portfolio management’s meaning can be explained as the process of managing
individuals’ investments so that they maximise their earnings within a given
time horizon. Furthermore, such practices ensure that the capital invested by
individuals is not exposed to too much market risk.
The entire process is based on the ability to make sound decisions. Typically,
such a decision relates to – achieving a profitable investment mix, allocating
assets as per risk and financial goals and diversifying resources to combat
capital erosion.
Primarily, portfolio management serves as a SWOT analysis of different
investment avenues with investors’ goals against their risk appetite. In turn, it
helps to generate substantial earnings and protect such earnings against risks.
Objectives of Portfolio Management
The fundamental objective of portfolio management is to help select best
investment options as per one’s income, age, time horizon and risk appetite.
Some of the core objectives of portfolio management are as follows –
 Capital appreciation
 Maximising returns on investment
 To improve the overall proficiency of the portfolio
 Risk optimisation
 Allocating resources optimally
 Ensuring flexibility of portfolio
 Protecting earnings against market risks
Nonetheless, to make the most of portfolio management, investors should opt
for a management type that suits their investment pattern.
Types of Portfolio Management
In a broader sense, portfolio management can be classified under 4 major types,
namely –
 Active portfolio management
In this type of management, the portfolio manager is mostly concerned with
generating maximum returns. Resultantly, they put a significant share of
resources in the trading of securities. Typically, they purchase stocks when they
are undervalued and sell them off when their value increases.
 Passive portfolio management
This particular type of portfolio management is concerned with a fixed profile
that aligns perfectly with the current market trends. The managers are more
likely to invest in index funds with low but steady returns which may seem
profitable in the long run.
 Discretionary portfolio management
In this particular management type, the portfolio managers are entrusted with
the authority to invest as per their discretion on investors’ behalf. Based on
investors’ goals and risk appetite, the manager may choose whichever
investment strategy they deem suitable.
 Non-discretionary management
Under this management, the managers provide advice on investment choices. It
is up to investors whether to accept the advice or reject it. Financial experts
often recommended investors to weigh in the merit of professional portfolio
managers’ advice before disregarding them entirely.
Who Should Opt for Portfolio Management?
The following should consider portfolio management –
 Investors who intend to invest across different investment avenues like
bonds, stocks, funds, commodities, etc. but do not possess enough
knowledge about the entire process.
 Those who have limited knowledge about the investment market.
 Investors who do not know how market forces influence returns on
investment.
  Investors who do not have enough time to track their investments or
rebalance their investment portfolio.
To make the most of the managerial process, individuals must put into practice
strategies that match the investor’s financial plan and prospect.
Ways of Portfolio Management
Several strategies must be implemented to ensure sound investment portfolio
management so that investors can boost their earnings and lower their risks
significantly.
Typically, professionals use these following ways to manage investment
portfolio –
 Asset allocation
Essentially, it is the process wherein investors put money in both volatile and
non-volatile assets in such a way that helps generate substantial returns at
minimum risk. Financial experts suggest that asset allocation must be aligned as
per investor’s financial goals and risk appetite.
 Diversification
The said method ensures that an investors’ portfolio is well-balanced and
diversified across different investment avenues. On doing so, investors can
revamp their collection significantly by achieving a perfect blend of risk and
reward. This, in turn, helps to cushion risks and generates risk-adjusted returns
over time.
 Rebalancing
Rebalancing is considered essential for improving the profit-generating aspect
of an investment portfolio. It helps investors to rebalance the ratio of portfolio
components to yield higher returns at minimal loss. Financial experts suggest
rebalancing an investment portfolio regularly to align it with the prevailing
market and requirements.
Once investors have selected a suitable strategy, they must follow a thorough
process to implement the same so that they can improve the portfolio’s
profitability to a great extent.
Processes of Portfolio Management

Steps Process of Investment Description

 Portfolio Management

Step 1 Identification of objectives For a capable investment portfolio, investors need to identify
– suitable objectives which can be either stable returns or capital
appreciation.

Step 2 Estimating the capital Expected returns and associated risks are analysed to take
– market necessary steps.

Step 3 Decisions about asset To generate earnings at minimal risk, sound decisions must be
– allocation made about the suitable ratio or asset combination.

Step 4 Formulating suitable Strategies must be developed after factoring in investment

– portfolio strategies horizon and risk exposure.

Step 5 Selecting of profitable The profitability of assets is analysed by factoring in their

– investment and securities fundamentals, credibility, liquidity, etc.

Step 6 Implementing portfolio The planned portfolio is put to action by investing in profitable
– investment avenues.

Step 7 Evaluating and revising the A portfolio is evaluated and revised regularly to evaluate its
– portfolio efficiency.

Step 8 Rebalancing the Portfolio’s composition is rebalanced frequently to maximise

– composition of the earnings.
portfolio

The fact that effective portfolio management allows investors to develop the
best investment plan that matches their income, age and risks taking capability,
makes it so essential. With proficient investment portfolio management,
investors can reduce their risks effectively and avail customised solutions
against their investment-oriented problems. It is, thus, one of the inherent parts
of undertaking any investment venture.
Who is a portfolio manager?
A portfolio manager is a person who takes investment decisions on behalf of
his investors. Their responsibility is to devise such investment strategies and
processes which match the needs and objectives of his client, build and manage
their investment portfolios and take investment decisions with such an objective
that the client gets maximum returns and minimize the possibility of losses.
Roles and Responsibilities of a portfolio manager
Following are the roles and responsibilities that a portfolio manager needs to
undertake:
1. Designing a best investment plan based on needs and situation of the
client: The primary role of a portfolio manager is to devise and design
best investment plans for his client based on the client’s age, income,
requirements, objectives and his risk appetite. Every investment plan
would be tailor-made for each of the client. A portfolio manager’s
attempt while designing such investment plan to maximize the returns on
the investment with minimum risk for the client.
2. Educating and making the client aware about various investment
tools: Another responsibility of a portfolio manager apart from designing
the investment plan is to educate and make his client aware of the variety
of investment tools that are available in the market and the associated
benefits which a client can avail from them. Once the client is made
aware of all the investment tools available in the market, he would be in a
better position to make investment decisions. Educating the client about
investment tools is considered to be a one of the best practices that is
followed in the industry. Such education also builds trust of the client in
the portfolio manager.
3. Designing tailor-made investment plans: The manager also needs to
design a custom-made investment plan which is specific to the needs and
financial situation and the investment objectives of the client. Every
client has different financial and investment objectives based on a
multiple of factors and keeping the same in mind, a customised
investment plan has to be designed. There cannot be one-size-fits-all
approach especially in portfolio management. So the manager first
analyses the financial background of the client, his investment objectives
and capacity to invest and then design the investment plan for him/her.
4. Be updated with the latest developments in the financial markets:
Another responsibility of the manager is to keep himself updated with
 latest developments taking place in the market and report any relevant
development with the client to take prompt actions so that returns can be
increased and risks are managed. An eye should be there on the market
fluctuations that are taking place and take proactive efforts to protect the
client’s investments.
5. Manage risks and contain losses: A portfolio manager’s duty is not
limited to making the investment plan but also to manage risks associated
with such investments and in adverse situations contain losses for the
client. Investment is not a fairy tale; there are always ups and downs
which an investor has to deal with. A classic example is that of Russia-
Ukraine conflict where the global financial markets have suffered to a
great extent with rising crude oil prices. In such adverse situation, the role
of a portfolio manager is to contain losses when every other person’s
investment is crashing down. The role is not always to make best
investment decisions but sometimes manage and contain losses when the
whole market is crashing down.
6. Measuring performance of investment portfolio: The manager must
check and measure the performance of the investment portfolio from time
to time so any sudden and drastic changes in the market does not affect
the client in an adverse manner. Constant performance check also
provides the opportunity to withdraw the investment from non-
performing assets and direct the existing assets to such areas where better
returns can be expected.
7. Being unbiased and becoming a through professional: A manager
should not always look for commissions. Instead his responsibility is to
exercise due care and caution while advising his clients and present
before him the best possible investment decisions in an unbiased manner.
This helps the client to take best possible decision for himself and in turn
instils confidence in the manager. Ideally, a manager should always be
transparent and honest with the client and refrain from pressurising the
client to take certain decisions.
8. Taking appropriate and correct decisions at the right time: Last but
not the least the manager should be an innovative and critical thinker to
be able to take correct decisions at the right time to maximize returns for
the client and minimize losses if any.
wealth management - An overview
 Wealth management is a comprehensive approach to financial planning
that extends beyond the management of investment portfolios. It
encompasses a wide range of financial services tailored to meet the
unique needs of high net-worth individuals (HNIs) and families.

The primary goal of wealth management is to preserve and grow your

wealth while addressing various aspects of your financial life. The key
elements of wealth planning may include:

 Risk management

It is one of the most crucial components of wealth management. It’s

because when you have substantial wealth and assets, they are exposed to
greater risks. Wealth managers work collaboratively to help you
safeguard your assets through insurance, investment, legal documents,
etc.

 Goal setting and financial planning

Wealth managers work closely with you to understand your unique

financial objectives and create a roadmap to achieve them. A well-
structured financial plan serves as the foundation for effective wealth
management.

 Asset management

Wealth management extends beyond simple financial advice. It

encompasses an intricate process that involves the management, transfer,
and safeguarding of your wealth and assets.

Types of wealth management services

Wealth management is an umbrella term that represents a wide range of

services. They include:

 Investment management
 Investment management is a crucial part of wealth management services.
Under this service, a wealth manager focuses on creating a well-rounded
investment portfolio comprising a mix of assets such as equity, real
estate, bonds, and alternative investments.

 Tax planning

Tax planning for HNIs involves much more complexity owing to their
large asset base. Wealth managers assist them to optimise their tax
situation by implementing strategies to minimise tax liabilities and
maximise after-tax returns.

 Estate planning

Estate planning involves drafting wills, establishing trusts, and

implementing gifting strategies to facilitate smooth wealth transfer and
asset distribution after your death.

 Retirement planning

Wealth managers help you plan for a comfortable retirement by

considering your lifestyle goals, expected expenses, and investment
strategies. They ensure you enjoy a comfortable retirement life without
compromising your current lifestyle.

Portfolio management - An overview

Portfolio management, on the other hand, is a sub-part of wealth

management that focuses specifically on the construction and
maintenance of your investment portfolio. Portfolio managers make
certain investment decisions on your behalf so that you can achieve your
financial goals within the desired time frame.

The key objectives of portfolio management are:

 Diversification

Portfolio managers diversify investments across various securities and

sectors, reducing the impact of poor performance in any single
investment.

 Asset allocation

Portfolio managers allocate investments across different asset classes,

including stocks, bonds, real estate, etc., based on your risk tolerance,
investment horizon, and financial goals.

 Rebalancing

Portfolio managers rebalance investment portfolios by analysing and

selecting individual securities and investment instruments based on their
risk and potential.

 Portfolio monitoring

Portfolio managers constantly monitor your investment portfolio to

ensure it aligns with your short-term and long-term financial goals.

Types of portfolio management services

Portfolio management services can be categorised into the following

types:

 Active and passive

Under active portfolio management, a portfolio manager constantly

monitors and modifies your investment portfolio as per the changing
market dynamics. On the other hand, under passive portfolio
management, portfolio managers make investments based on your
financial goals but do not track them constantly.
 Discretionary and non-discretionary

Under discretionary portfolio management, the clients give portfolio

managers complete authority to make changes in their investment
portfolios. Under non-discretionary portfolio management, on the other
hand, the portfolio manager only provides suggestions, advice, and
recommendations.

Portfolio management vs wealth management

The table below illustrates the difference between portfolio

management and wealth management based on various parameters:

Portfolio
Parameter Wealth Management
Management

The scope of wealth

The scope of portfolio management extends
management services is beyond the client’s
Scope
limited to the client’s investment portfolio,
investment portfolio. encompassing a wide array
of services.

The goal is to fetch

maximum returns The goal is to ensure the
Goals based on the client’s overall financial well-being
risk profile and of the client.
financial goals.

Portfolio managers
Wealth managers protect
ensure their clients’
Responsibility the overall wealth and
portfolio generates the
assets of their clients.
desired returns.

The focus is on
Considers the broader
Risk managing risks within
perspective of a client’s
management an investment
financial risk.
portfolio.
 What is Derivatives?
Derivatives are contracts, and the value is determined by the underlying
asset. These are frequently utilized to speculate and profit. Some people
also utilized them to shift risk.
Definition of Derivatives
Derivatives are financial contracts, and their value is determined by the
value of an underlying asset or set of assets. Stocks, bonds, currencies,
commodities, and market indices are all common assets.
The underlying assets' value fluctuates in response to market conditions.
The main idea behind getting into derivative contracts is to benefit by
betting on the future value of the underlying asset.
Consider the possibility that the market price of an equity share will rise
or fall. A drop in the stock value may cause you to lose money.
You can enter a derivative contract, in this case, to generate gains by
placing an appropriate bet. Alternatively, you might simply protect
yourself from losses in the spot market where the stock is traded.
Types of Derivatives
Mentioned here are the types of derivatives in the market-
1) Forwards
 It is a tailored agreement between two parties to buy or sell an asset, a
product, or a commodity at a defined price at a future date.
 Forwards are not traded on any central exchanges but rather over-the-
counter, and they are not standardized to be controlled. As a result, even
if it does not guarantee any gains, it is largely effective for hedging and
reducing risk.
 Over-the-counter Forwards are also subject to counterparty risk.
Counterparty risk is a type of credit risk in which the buyer or seller may
be unable to fulfil his or her obligations.
 If a buyer or seller goes bankrupt and is unable to fulfil his or her
obligations, the other party may be without remedy to salvage his or her
position.
2) Options
 Options are financial contracts in which the buyer or seller has the option
to buy or sell a security or financial asset but not the obligation to do
so. Options are quite similar to futures.
 It is a contract or agreement between two parties to buy or sell any form
of security at a certain price in the future.
 The parties, on the other hand, are under no legal responsibility to keep
their end of the contract, which means they can sell or buy the security at
any time.
 It is simply an option provided to lessen risk in the future if the market is
volatile.
3) Futures
 Futures are financial contracts that are basically identical to forwards,
with the main distinction being that features can be exchanged on
exchanges, resulting in standardization and regulation.
 They're frequently utilized in commodity speculation.
4) Swaps
 Swaps, as the name implies, are exactly what they sound like. Swaps are
a type of financial derivative used to convert one type of cash flow into
another.
 Swaps are private agreements between parties that are primarily
exchanged over the counter and are not traded on stock exchanges.
 Currency swaps and interest rate swaps are the two most popular types of
swaps. An interest rate swap, for example, can be used to convert a
variable-interest loan to a fixed-interest loan or vice versa.
How to Trade Derivatives?
Every financial market is influenced by a variety of elements, including
economic, political, and social concerns. Any one of these influencing
elements is sufficient to induce a large market shift.
It is prudent to educate oneself completely on current market
circumstances and the variables that are likely to influence them. As a
result - you must be aware of these developments and be prepared ahead
of time.
Here's how you can make money trading derivatives-
 Step 1: Before you can start trading in various types of derivatives, you
must first open an online trading account. If you're trading derivatives
through a broker, you can take orders over the phone or even online.
Step 2: You must pay a margin amount when you begin trading
derivatives and their types, which you cannot withdraw until the contract
is completed and the trade is concluded. Suppose your margin goes below
the minimum permissible amount while trading; you will receive a
margin call to rebalance it.
Step 3: Make sure you know everything there is to know about the
underlying asset. Keep your budget in mind and make sure it's sufficient
for fulfilling the financial requirements of the margin for trading, cash on
hand, and contract prices.
Step 4: You should keep your investment in the contract until the trade is
resolved.
Advantages of Derivatives
 There are Lower Transaction Costs
When compared to other securities, such as stocks or bonds, trading in the
derivatives markets has a low transaction cost. As derivatives are
primarily used to control risk, they ensure lower transaction costs.
 Hedging Risks
Hedging risk is the process of reducing risk in one's investment by
forming a new one, and derivatives are the best way to do it.
Derivatives are utilized as insurance policies to mitigate risk, and they are
typically used with the goal of reducing market risk.
Disadvantages of Derivatives
Loss of adaptability. Because standardized contracts for exchange-traded
derivatives cannot be tailored, the market becomes less flexible. There is
no negotiating involved, and many of the conditions of the derivative
contract are already specified.
What are Futures and Forwards?
Future and forward contracts (more commonly referred to as futures and
forwards) are contracts that are used by businesses and investors
to hedge against risks or speculate. Futures and forwards are examples of
derivative assets that derive their values from underlying assets. Both
 contracts rely on locking in a specific price for a certain asset, but there
are differences between them.
Types of Underlying Assets
Underlying assets generally fall into one of three categories:
Financial
Financial assets include stocks, bonds, market indices, interest rates,
currencies, etc. They are considered to be homogenous securities that are
traded in well-organized, centralized markets.
Commodities
Examples of commodities are natural gas, gold, copper, silver, oil,
electricity, coffee beans, sugar, etc. These types of assets are less
homogenous than financial assets and are traded in less centralized
markets around the world.
Other
Some derivatives exist as hedges against events such as natural
catastrophes, rainfall, temperature, snow, etc. This category of derivatives
may not be traded at all on exchanges, but rather as contracts between
private parties.
Definitions
Forward Contracts
A forward contract is an obligation to buy or sell a certain asset:
 At a specified price (forward price)
 At a specified time (contract maturity or expiration date)
 Typically not traded on exchanges
Sellers and buyers of forward contracts are involved in a forward
transaction – and are both obligated to fulfill their end of the contract at
maturity.
Futures Contracts
Futures are the same as forward contracts, except for two main
differences:
  Futures are settled daily (not just at maturity), meaning that futures can be
bought or sold at any time.
 Futures are typically traded on a standardized exchange.
The table below summarizes some key differences between futures and
forwards
The table below summarizes some key differences between futures and
forwards:
Futures Forwards
Settled Daily Settled at Maturity
Standardized Not Standardized
Low risk of not fulfilling obligations, due to Low level of regulation and oversight
regulation and oversight on settlement
Traded on Public Exchanges Private contract between two parties
Forward Contract Example
Suppose that Ben’s coffee shop currently purchases coffee beans at a
price of $4/lb. from his supplier, CoffeeCo. At this price, Ben’s is able to
maintain healthy margins on the sale of coffee beverages. However, Ben
reads in the newspaper that cyclone season is coming up and this may
threaten to destroy CoffeCo’s plantations. He is worried that this will
lead to an increase in the price of coffee beans, and thus compress his
margins. CoffeeCo does not believe that the cyclone season will destroy
its operations. Due to planned investments in farming equipment,
CoffeeCo actually expects to produce more coffee than it has in previous
years.
Ben’s and CoffeeCo negotiate a forward contract that sets the price of
coffee to $4/lb. The contract matures in 6 months and is for 10,000 lbs. of
coffee. Regardless of whether cyclones destroy CoffeeCo’s plantations or
not, Ben is now legally obligated to buy 10,000 lbs of coffee at $4/lb
(total of $40,000), and CoffeeCo is obligated to sell Ben the coffee under
the same terms. The following scenarios could ensue:
Scenario 1 – Cyclones destroy plantations
In this scenario, the price of coffee jumps to $6/lb due to a reduction in
supply, making the transaction worth $60,000. Ben benefits by only
paying $4/lb and realizing $20,000 in cost savings. CoffeeCo loses out as
they are forced to sell the coffee for $2 under the current market price,
thus incurring a $20,000 loss.
Scenario 2 – Cyclones do not destroy plantations
In this scenario, CoffeeCo’s new farm equipment enables them to flood
the market with coffee beans. The increase in the supply of coffee
reduces the price to $2/lb. Ben loses out by paying $4/lb and pays
$20,000 over the market price. CoffeeCo benefits as they sell the coffee
for $2 over the market value, thus realizing an additional $20,000 profit.

Futures Contract Example

Suppose that Ben’s coffee shop currently purchases coffee beans at a
price of $4/lb. At this price, Ben’s is able to maintain healthy margins on
the sale of coffee beverages. However, Ben reads in the newspaper that
cyclone season is coming up and this may threaten to destroy coffee
plantations. He is worried that this will lead to an increase in the price of
coffee beans, and thus compress his margins.
Coffee futures that expire six months from now (in December 2018) can
be bought for $40 per contract. Ben buys 1000 of these coffee bean
futures contracts (where one contract = 10 lbs of coffee), for a total cost
of $40,000 for 10,000 lbs ($4/lb). Coffee industry analysts predict that if
there are no cyclones, advancements in technology will enable coffee
producers to supply the industry with more coffee.
Scenario 1 – Cyclones destroy plantations
The following week, a massive cyclone devastates plantations and causes
the price of December 2018 coffee futures to spike to $60 per contract.
Since coffee futures are derivatives that derive their values from the
values of coffee, we can infer that the price of coffee has also gone up.
In this scenario, Ben has made a $20,000 capital gain since his futures
contracts are now worth $60,000. Ben decides to sell his futures and
invest the proceeds in coffee beans (which now cost $6/lb from his local
supplier), and purchases 10,000 lbs of coffee.
Scenario 2 – Cyclones do not destroy plantations
Coffee industry analyst predictions were correct, and the coffee industry
is flooded with more beans than usual. Thus, the price of coffee futures
drops to $20 per contract. In this scenario, Ben has incurred a $20,000
capital loss since his futures contracts are now worth only $20,000 (down
from $40,000). Ben decides to sell his futures and invest the proceeds in
coffee beans (which now cost $2/lb from his local supplier), and
purchases 10,000 lbs of coffee.
Understanding Options
Options are versatile financial products. These contracts involve a buyer
and seller, where the buyer pays a premium for the rights granted by the
contract. Call options allow the holder to buy the asset at a stated price
within a specific time frame. Put options, on the other hand, allow the
holder to sell the asset at a stated price within a specific time frame. Each
call option has a bullish buyer and a bearish seller while put options have
a bearish buyer and a bullish seller.1
U.S. Securities and Exchange Commission. "Investor Bulletin: An
Introduction to Options."
Traders and investors buy and sell options for several reasons. Options
speculation allows a trader to hold a leveraged position in an asset at a
lower cost than buying shares of the asset. Investors use options to hedge
or reduce the risk exposure of their portfolios.
In some cases, the option holder can generate income when they buy call
options or become an options writer. Options are also one of the most
direct ways to invest in oil. For options traders, an option's daily
trading volume and open interest are the two key numbers to watch to
make the most well-informed investment decisions.
Types of Options
Calls
A call option gives the holder the right, but not the obligation, to buy the
underlying security at the strike price on or before expiration. A call
option will therefore become more valuable as the underlying security
rises in price (calls have a positive delta).3
A long call can be used to speculate on the price of the underlying rising,
since it has unlimited upside potential but the maximum loss is the
premium (price) paid for the option.
Puts
Opposite to call options, a put gives the holder the right, but not the
obligation, to instead sell the underlying stock at the strike price on or
before expiration. A long put, therefore, is a short position in the
underlying security, since the put gains value as the underlying's price
falls (they have a negative delta).3 Protective puts can be purchased as a
sort of insurance, providing a price floor for investors to hedge their
positions.
Understanding Swaps Derivatives Meaning
Swaps in derivatives are contracts or agreements between two parties
which allow them to exchange liabilities and cash flows from several
different financial instruments. Cash flow based on the notional principal
of bonds and loans is most commonly involved in swaps. Any legally or
financially valued instrument may be the underlying instrument used in
swaps.
In swap contracts, the principal amount usually is not transferred. In
addition, both cash flows remain fixed, and the other remains variable.
The currency exchange rate, the benchmark interest rate or index rates
shall be used as a basis for irregular cash flows. In addition, every
exchange of funds is referred to as the Legged Transaction. Uncertain or
random variables such as the foreign exchange rate, equity price, interest
rate or commodity price will determine at least one of the cash flows at
the start of the contract.
How does Swap Work?
Each swap contract is unique and customised. A standardised format is
not available. The parties reach an agreement based on negotiations and
conditions agreed upon. In addition, the contract is based on the notional
principal amount and the cash flows generated are exchanged between the
parties. Exchanges of cash flows will occur at a particular period
according to the frequencies mentioned, i.e. between the starting and
ending dates of the contract.
A financial regulator does not regulate these contracts because they are
traded in the open market. As a result, they are a risky instrument because
of the increased risk of counterparty default. Furthermore, there are
various swap agreements in operation, and each type of contract has a
specific purpose.
In most cases, businesses apply swaps to protect their risks and reduce the
uncertainty of operations. Large companies, on the other hand, can
finance their activities using bonds that yield interest to investors.
However, if the company does not like interest payments, it may choose
another firm for a swap.
Types of Swaps
The most common types of swaps used in the Indian capital markets are
as follows.
1. Interest Rate Swap In interest rate swaps, commonly called plain
vanilla swap contracts, counterparties trade cash flows to speculate or
hedge interest rate risk. In general, such agreements are concerned with
the exchange of a fixed rate for a floating rate. The cash flows will be
based on the nominal underlying amount to which both sides agree but
are not exchanged.
2. Currency Swaps The swap is for exchanging interest rates and
principal payments on debt amounting to various currencies.
Furthermore, it is exchanged together with specific interest obligations
rather than being based on a notional principal amount. In addition, these
agreements may take place in different countries.
3. Commodity Swaps The exchange of cash flows, dependent upon the
price of commodities, is involved in commodity swaps. This contract
includes two components: floating legs and fixed legs. The cost of the
underlying item, such as oil, fuel, precious metal and so on, will be
subject to a floating portion. The contract will state the firm leg according
to the commodity producer.
4. Debt Equity Swaps Debt Equity Swaps involve the exchange of debt
and equity or vice versa. This is a financial restructuring procedure where
one party shares its debt with the other in exchange for an equity position.
That is to say, a debt holder obtains an equity position to cancel the debt.
Creditors forced to enter into such agreements due to bankruptcy can
decide whether or not they wish to participate. In contrast, other creditors
may choose to do so if they can benefit from favourable market
conditions.
5. Total Return Swaps Total Return Swap is a mechanism for
exchanging full returns from an asset at its assigned interest rate. This
results in a fixed rate for an underlying asset such as stocks, bonds and
indexes being charged to the party. Consequently, the benefit of this asset
is passed on to the other party without the actual ownership of the asset.
The parties to this swap contract are a total return payer and a total return
receiver.
Benefits and Risks of Swaps Derivatives
The benefits of swaps in derivatives are as follows.
1. Hedging Risk Hedging of risks is the main advantage of swaps. It may
help a party to reduce the risk associated with market fluctuations. For
example, interest rate swaps are used to hedge the risk of changes in
interest rates, while foreign exchange swap is used for hedging against
currency fluctuations.
2. Access to New Markets Under these arrangements, investors or firms
can enter unavailable new markets.
The most significant risk of derivatives swaps is the following.
1. Interest rate risk The movements in interest rates do not necessarily
correspond to the expectations of these swap contracts. As a result, they
are vulnerable to interest rate risk. In other words, only if the interest rate
falls will the receiver profit, while the payer will profit only if the interest
rate increases.
2. Credit risk Swaps are exposed to the credit risks of counterparties.
This is because the other party to the contract tends to default on the
payment. However, it is only possible to mitigate this risk to a certain
extent.
Conclusion
Swaps in financial markets involve a derivative contract where one side
exchanges the value of an asset or cash flow for another. For example, a
variable interest-paying company could swap its interest payment with
another firm that would pay an identical rate to the first one. Swaps can
exchange other types of risks or values, e.g., potential credit default in a
bond.
Who is a Portfolio Manager?
A portfolio manager is a body corporate who, based on a contract with a
client, advises, directs, or manages a client's securities or funds. They
operate either as a discretionary portfolio manager, making investment
decisions independently based on the client's needs, or as a non-
discretionary portfolio manager, acting on the client's directions.
Steps to Become a Registered Portfolio Manager
1. Fulfill Eligibility Criteria
To qualify as a portfolio manager, the applicant must meet specific
criteria set by SEBI, including professional qualifications, experience in
the financial services sector, and a strong financial background.
2. Application Process
The aspiring portfolio manager must submit an application in Form A,
along with a non-refundable fee of Rs. 1,00,000 by demand draft in favor
of ‘Securities and Exchange Board of India’, payable at Mumbai. The
application and additional information should be sent to the Investment
Management Department - Division of Funds-1, SEBI Bhavan, Mumbai.
3. Capital Adequacy Requirement
Applicants must demonstrate a minimum net worth of Rs. 2 crore,
ensuring they have the financial stability to manage clients' funds
effectively.
4. Registration Fee
Upon approval, the portfolio manager must pay a registration fee of Rs.
10 lakhs to SEBI for the grant of the certificate of registration.
5. Certificate of Registration
The certificate of registration is valid for three years. Portfolio managers
must apply for renewal three months before the expiry, with a renewal fee
of Rs. 5 lakh.
6. Client Agreement
 Before managing funds or a portfolio of securities, the portfolio manager
must enter into a written agreement with the client, defining their
relationship, rights, liabilities, and obligations as specified in Schedule IV
of the SEBI (Portfolio Managers) Regulations, 1993.
Responsibilities and Compliance
 Client Fees: Portfolio managers can charge their clients based on the
agreement, which may include a fixed amount, a return-based fee, or a
combination of both.
 Minimum Investment Requirement: Portfolio managers must accept a
minimum of Rs. 5 lakhs or securities of equivalent value from clients for
portfolio management services.
 Investor Demat Account: For investment in listed securities, investors
are required to open a demat account in their name.
 Reporting and Disclosure: Portfolio managers must provide periodic
reports to clients, detailing portfolio composition, transactions, and
performance. They must also furnish a Disclosure Document to clients
before entering into an agreement, outlining fees, risks, and other critical
information.
SEBI’s Role and Investor Protection
SEBI does not approve the services offered by portfolio managers but
regulates their activities to protect investors. Investors can find
information about registered portfolio managers on SEBI's website and
have a mechanism for redressal of complaints through SEBI's Office of
Investor Assistance and Education.
Conclusion
The path to becoming a registered portfolio manager in India involves
stringent eligibility criteria, a comprehensive application process, and
adherence to SEBI's regulations. By ensuring transparency, financial
stability, and accountability, SEBI aims to protect investors while
fostering a healthy investment management ecosystem. Aspiring portfolio
managers must navigate these requirements carefully, demonstrating their
capability to manage client funds effectively and ethically.
Abstract
 Powers And Functions Of SEBI -SEBI is a statutory regulatory body that
stands for Securities And Exchange Board Of India which is responsible
to regulate the Indian capital markets.
It was set-up to prevent malpractices in the capital market and to promote
the development of the capital market because people were losing
confidence in the stock market, so the government felt a sudden need to
set up an authority to regulate the working and to reduce malpractices.
SEBI ensures that the capital market operates in a systematic manner and
provides its investors such a transparent environment for their investment.
It monitors and regulates the securities market and protects the interests
of the investors by enforcing certain rules and regulations.[1]
History
Powers And Functions Of SEBI – SEBI was originally established on 12
April 1988 by the government of India.
In April 1988, The SEBI was constituted as the regulator of capital
markets under the resolution of the Indian government.
Initially, SEBI was a non-statutory body, later it became an ‘autonomous’
body on 30 January, 1992, after the Indian parliament passed the SEBI
Act, 1992.
In 1995, the Indian government through an amendment to the Securities
And Exchange Board Of India Act, 1992, was given additional statutory
powers.
Its headquarter is located in Mumbai, and regional offices in New Delhi,
Kolkata, Chennai and Ahmedabad.
SEBI is managed by its members, consists of the following
i. A chairman, nominated by the union government of India;
ii. Two members, Officers from union finance ministry;
iii. One member from the Reserve Bank Of India;
iv. Five members, nominated by the union government of India, three out of
them shall be full-time members.[2]
Powers of SEBI
1. SEBI has powers relating to stock exchanges and intermediaries i.e. It can
ask about information regarding business transactions for inspection or
scrutiny and other purposes.
2. SEBI has the power to impose monetary penalties on capital market
intermediaries. It can also impose a suspension of their registration for a
small period.
3. It has the power to initiate actions into functions assigned.
4. Has the power to regulate insider trading.
5. Also has powers under the securities contracts act i.e. SEBI has
empowered by the finance ministry to nominate three members on the
governing body of every stock exchange.[3]
6. It has the power to regulate the business of the stock exchange.
Functions of SEBI
SEBI has three functions:
1. Protective Function: SEBI performs these functions to protect the
interest of investors and other financial participants.
(i)Safeguard the interests of traders and investors.
(ii)Limit price rigging, as some of them is already fix (price rigging) by
the corporate or group of corporate.
(iii)Prevent insider trading.
(iv)Promote fair practices, ensure that all the market transactions take
place smoothly and securely.
(v)Prohibits unfair trade practices.
2. Development Function: It brings freshness and innovations to the
Indian financial market.
(i) Offering training to financial intermediaries.
(ii) Introducing DEMAT form of securities.
(iii) Buying- selling mutual funds directly from AMC through a broker.
(iv) Encouraging self-regulating organisations.
(v) Promoting fair trade practices and reducing unfair trade practices.[4]
3.Regulatory Function: This function ensures the smooth and
transparent functioning of the stock market.
It regulates the functioning of mutual funds and the takeover of
companies.
All intermediaries, brokers, sub-brokers, merchant bankers, trustees etc
register in SEBI.
Conducts inquiries and audit of exchanges.

Unit – 2
Introduction : Risk can be defined as the chance of loss or an unfavorable
outcome associated with an action. Uncertainty does not know what will
happen in the future, the greater the uncertainty, the greater the risk. For
an individual, risk management involves optimizing expected returns
subject to the risks involved and risk tolerance. Risk is what makes it
possible to make a profit. If there was no risk, there would be no return to
the ability to successfully manage it. For each decision there is a risk
return tradeoff. Anytime there is a possibility of loss (risk), there should
be an opportunity for profit. Risk management is the process of
identifying, assessing and controlling threats to an organization’s capital
and earnings. These threats, or risk, could stem from a wide variety of
sources, including financial uncertainty, legal liabilities, strategic
management errors, accidents and natural disasters. IT security threats
and data-related risks, and the risk management strategies to alleviate
them have become a top priority for digitized companies. As a result, a
risk management plan increasingly includes companies’ processes for
identifying and controlling threats to its digital assets, including
proprietary corporate data, a customer’s personally identifiable
information and intellectual property.
Definition of Risk Management
Risk management is an integrated process of delineating (define) specific
areas of risk, developing a comprehensive plan, integrating the plan, and
conducting the ongoing evaluation’ – Dr. P.K. Gupta.

Risk Management Process :

1. Establish the Context : The purpose of this stage of planning enables to
understand the environment in which the respective organization
operates, that means the thoroughly understand the external environment
and the internal culture of the organization. You cannot resolve a risk if
you do not know that it is. At the initial stage it is necessary to establish
the context of risk. To establish the context there is a need to collect
relevant data. There is a need to map the scope of the risks and objectives
of the organization.
2. Identification : After establishing the context, the next step in the
process of managing risk is to identify potential risks. Risks are about
events that, when triggered, will cause problems. Hence, risk
identification can start with the source of problems, or with the problem
itself. Establishment the context Identification Assessment.
3. Assessment : Once risks have been identified, they must then be
assessed as to their potential severity of loss and to the probability of
occurrence. These quantities can be either simple to measure, in the case
of the value of a lost building, or impossible to know for sure in the case
of the probability of an unlikely event occurring. Therefore, in the
assessment process it is critical to make the best educated guesses
possible in order to properly prioritize the implementation of the risk
management plan. The fundamental difficulty in risk assessment is
determining the rate of occurrence since statistical information is not
available on all kind of past incidents.
4. Potential Risk Treatments : Once risks have been identified and
assessed, all techniques to manage the risk fall into one or more of these
four major categories.
a) Risk Transfer : Risk transfer means that the expected party transfers
whole or part of the losses consequential to risk exposure to another party
for a cost. The insurance contracts fundamentally involve risk transfers.
Apart from the insurance device, there are certain other techniques by
which the risk may be transferred.
b) Risk Avoidance : Avoid the risk or the circumstances which may lead
to losses in another way, includes not performing an activity that could
carry risk. Avoidance may seem the answer to all risks but avoiding risks
also means losing out on the potential gain that accepting (retaining) the
risk may have allowed. Not entering a business to avoid the risk of loss
also avoids the possibility of earning the profits.
c) Risk Retention : Risk retention implies that the losses arising due to a
risk exposure shall be retained or assumed by the party or the
organization. Risk retention is generally a deliberate decision for business
organizations inherited with the following characteristics. Self-insurance
and Captive insurance are the two methods of retention. A ‘captive
insurer’ is generally defined as an insurance company that is wholly
owned and controlled by its insured’s; its primary purpose is to insure the
risks of its owners, and its insured’s benefit from the captive insurer's
underwriting profits
Risk Control : Risk can be controlled wither by avoidance or by
controlling losses. Avoidance implies that either a certain loss exposure is
not acquired or an existing one is neglected. Loss control can be
exercised in two ways – (i) Create the plan and (ii) Risk Control.
i. Create the Plan : Decide on the combination of methods to be
used for each risk. Each risk management decision should be
recorded and approved by the appropriate level of management.
For example, a risk concerning the image of the organization
should have top management decision behind it. Whereas, IT
management would have the authority to decide on computer
virus risks. The risk management plan should propose
applicable and effective security controls for managing the
risks. A good risk management plan should contain a schedule
for control implementation and responsible persons for those
actions. The risk management concept is old but is still not very
effectively measured. Example – An observed high risk of
computer viruses could be mitigated by acquiring and
implementing antivirus software.
ii. ii. Risk Control : Once the risk is evaluated, it has to be
controlled. In the case of the worker working under the machine
that will fall any moment on top of him, risk control implies
primarily moving the worker from under there and then fixing
the machine so as it does not fall on anyone. Thus the steps
involved are immediate directions preventing the risk and
isolating or better removing the hazard to eliminate the risk.
5. Review and evaluation of the plan : Initial risk management
plans will never be perfect. Practice, experience and actual loss
results, will necessitate changes in the plan and contribute
information to allow possible different decisions to be made in
dealing with the risk being faced. Risk analysis results and
 management plans should be updated periodically. There are
two primary reasons for this –

a) To evaluate whether the previously selected security controls

are still applicable and effective and

b) To evaluate the possible risk level changes in the business

movement. There are risks that do no change and are static in
nature. However, other dynamic risks of not continually
monitored and reviewed may grow like a bubble and their
financial, legal and ethical impacts soon get out of control.

SYSTEMATIC RISK

It affects the entire market. It indicates that the entire market is

moving in particular direction. It affects the economic, political,
sociological changes. This risk is further subdivided into: 1.
Market risk 2. Interest rate risk 3. Purchasing power risk

1. Market risk: Jack Clark Francis defined market risk as “portion of

total variability in return caused by the alternating forces of bull
and bear markets. When the security index moves upward for a
significant period of time, it is bull market and if the index declines
from the peak to market low point is called troughs i.e. bearish for
significant period of time. The forces that affect the stock market
are tangible and intangible events. The tangible events such as
earthquake, war, political uncertainty and fall in the value of
currency. Intangible events are related to market psychology. For
example – In 1996, the political turmoil and recession in the
economy resulted in the fall of share prices and the small investors
lost faith in market. There was a rush to sell the shares and stocks
that were floated in primary market were not received well.

2. 2. Interest rate risk: It is the variation in single period rates of

return caused by the fluctuations in the market interest rate. Mostly
it affects the price of the bonds, debentures and stocks. The
fluctuations in the interest rates are caused by the changes in the
government monetary policy and changes in treasury bills and the
government bonds. Interest rates not only affect the security traders
 but also the corporate bodies who carry their business with
borrowed funds. The cost of borrowing would increase and a heavy
outflow of profit would take place in the form of interest to the
capital borrowed. This would lead to reduction in earnings per
share and consequent fall in price of shares. EXAMPLE –In April
1996, most of the initial public offerings of many companies
remained under subscribed, but IDBI & IFC bonds were over
subscribed. The assured rate of return attracted the investors from
the stock market to the bond market.

3. Purchasing power risk: Variations in returns are due to loss of

purchasing power of currency. Inflation is the reason behind the
loss of purchasing power. The inflation may be, “demand-pull or
cost-push “. Demand pull inflation, the demand for goods and
services are in excess of their supply. The supply cannot be
increased unless there is an expansion of labour force or machinery
for production. The equilibrium between demand and supply is
attained at a higher price level. Cost-push inflation, the rise in price
is caused by the increase in the cost. The increase in cost of raw
material, labour, etc makes the cost of production high and ends in
high price level. The working force tries to make the corporate to
share the increase in the cost of living by demanding higher wages.
Hence, Cost-push inflation has a spiraling effect on price level.

UNSYSTEMATIC RISK Unsystematic risk stems from managerial

inefficiency, technological change in production process,
availability of raw materials, change in consumer preference and
labour problems. They have to be analysed by each and every firm
separately. All these factors form Unsystematic risk. They are 1.
Business risk 2. Financial risk
1. BUISNESS RISK: It is caused by the operating environment
of the business. It arises from the inability of a firm to
maintain its competitive edge and the growth or stability of
the earnings. The variation in the expected operating income
indicates the business risk. It is concerned with difference
between revenue and earnings before interest and tax. It can
be further divided into:

2.  Internal business risk  External business risk

 Internal business risk - it is associated with the operational
efficiency of the firm. The efficiency of operation is reflected on
the company’s achievement of its goals and their promises to its
investors.

The internal business risks are:

 Fluctuation in sales  Research and development  Personal

management  Fixed cost  Single product

External business risk –It is the result of operating conditions

imposed on the firm by circumstances beyond its control. The
external business risk are,  Social and regulatory factors  Political
risk  Business cycle.

3. FINANCIAL RISK:
It is the variability of the income to the equity capital due to
the debt capital. Financial risk is associated with the capital
structure of the firm. Capital structure of firm consists of
equity bonds and borrowed funds. The interest payment
affects the payments that are due to the equity hareholders is
known as financial leverage. The financial risk considers the
difference between EBIT and EBT. The business risk causes
the variation between revenue and EBIT. The financial risk
is an avoidable risk because it is the management which has
to decide how much has to be funded with equity capital and
borrowed capital.investors.

Here are some elements of risk management:

 Risk identification: The process of documenting risks that could prevent
an organization from reaching its goals. Risks can include financial
challenges, operational obstacles, strategic uncertainties, or compliance
issues.
 Risk analysis: The process of examining risk sources, their positive and
negative consequences, and the likelihood of those consequences. It also
involves assessing existing controls or processes that can minimize
negative risks or enhance positive risks.
 Risk mitigation: The process of deciding which risks to eliminate or
minimize, and how many to retain. This can be achieved through selling
 assets or liabilities, buying insurance, hedging with derivatives, or
diversification.
 Risk acceptance: Accepting risks and devising strategies to control and
monitor them.
 Risk monitoring: The process of monitoring and reviewing the risk.

Strategies for Portfolio Risk Management

.Diversification
Diversification is one of the most important and effective
strategies for managing risk in stock market investing. The logic
behind diversification is simple: don’t put all your eggs in one
basket. By spreading investment capital across different stocks,
market sectors, asset classes, industries, and geographic regions,
investors reduce the overall volatility and risk profile of their
portfolio.
2. Asset Allocation
Asset allocation involves dividing an investment portfolio
between different asset classes to optimize the risk-return
profile aligned with an investor’s financial goals, time horizon,
and risk tolerance. The three main asset classes are stocks,
bonds, and cash equivalents. Allocating capital across these
assets is a fundamental way to manage risk in stock market
investing.
3. Hedging
Hedging involves making investments to specifically reduce the
risk in a stock portfolio by offsetting potential losses. Hedging
tools allow investors to mitigate risks related to market
volatility, interest rates, currencies, credit, and other market
variables. Common hedging strategies for stock investors
include options, futures and forwards, exchange-traded funds,
and short selling.
4. Risk-Adjusted Return Measures
In stock investing, focusing only on total returns does not
provide the full picture of an investment’s performance. The
key is assessing returns in the context of the risk taken to
generate those returns. Stocks with higher returns sometimes
simply take on greater risk. Analyzing risk-adjusted returns
allows for more accurate comparisons between investment
options to make informed decisions.
5. Stop-Loss Orders and Take-Profit Orders
Stop-loss and take-profit orders are two types of advanced trade
orders that investors use to manage risks associated with stock
positions. Stop-losses close out trades at predetermined prices to
limit potential losses should the share price fall. Take-profits
lock in gains by exiting trades once the stock hits a desired
upside target.
6. Rebalancing
Rebalancing involves periodically adjusting a portfolio’s
allocations back to the original target levels as asset classes drift
apart over time. Rebalancing forces investors to sell high and
buy low and is crucial for controlling risk in a stock portfolio.
7. Liquidity Management
Liquidity refers to how easily an asset is able to be converted
into cash. In the stock market, liquidity management is crucial
for investors, portfolio managers, and brokers to ensure efficient
trading and minimal price impact from buying and selling
securities.
8. Credit Risk Management
Credit risk refers to the potential for loss arising from a
borrower or counterparty failing to meet their financial
obligations. Effective credit risk management is critical for
stock market participants, including brokers, clearing houses,
exchanges, and investors.
9. Interest Rate Risk Management
Changes in interest rates significantly impact the stock market,
influencing investor psychology, cost of capital, and discount
rates. Therefore, effectively managing interest rate risk is
crucial for equity investors, brokers, corporations, and other
market entities.
10. Currency Risk Management
Currency rate fluctuations significantly impact global financial
markets, including equities. Managing currency risk is,
therefore, crucial for investors, multinational corporations, and
other players operating across borders.

Difference between Risk and Uncertainty

 Risk and Uncertainty are often used
interchangeably. Risk involves situations where the probability
of outcomes can be estimated or calculated based on available
data or models; whereas, Uncertainty arises when outcomes are
unknown or unpredictable due to lack of information or
complexity.
What is Risk?
Risk refers to the probability or likelihood of an event or
outcome occurring, along with its potential consequences. In
other words, it involves uncertainty about the future,
particularly regarding the occurrence of adverse events or
losses.
Features of Risk are:
 Probability: Risk is associated with the likelihood of different outcomes
or events happening. It can range from highly probable events to highly
improbable ones.
 Consequences: Risk considers the potential impact or consequences of
an event, which may include financial losses, physical harm, or other
negative effects.
 Measurement: Risks can be quantified and measured, often using
probabilistic methods, statistical analysis, or risk assessment techniques.
This allows for the estimation of the likelihood and severity of potential
outcomes.
 Management: Risk Management involves identifying, assessing,
and mitigating risks to minimize their impact or likelihood of occurrence.
This may include implementing preventive measures, risk transfer (such
as insurance), risk avoidance, or risk acceptance strategies.
What is Uncertainty?
Uncertainty refers to a situation where the outcome or consequences of an event
are unknown, unpredictable, or cannot be reliably estimated. It involves a lack
of clarity or certainty about future events, conditions, or outcomes, which may
arise due to various factors such as incomplete information, complexity,
randomness, ambiguity, or novelty.
Features of Uncertainty include:
 Unknown Future: Uncertainty arises when there is a lack of knowledge
or information about future events or outcomes. This can be due to
 incomplete data, unforeseen circumstances, or the inability to accurately
predict future trends or developments.
 Unpredictability: Uncertainty involves events or situations that are
inherently unpredictable or difficult to forecast. This unpredictability
makes it challenging to anticipate the likelihood or timing of future
events and their potential consequences.
 Ambiguity: Uncertainty often involves ambiguity or vagueness about the
nature, scope, or implications of future events. This ambiguity can stem
from conflicting information, multiple possible interpretations, or
complex interdependencies between different factors.
 Risk of Error: Uncertainty introduces a risk of error or miscalculation
in decision-making, as outcomes may deviate from expectations or
assumptions. This risk can lead to suboptimal choices, unexpected
outcomes, or unanticipated consequences.

Difference between Risk and Uncertainty

The difference between risk and uncertainty can be drawn clearly on the
following grounds:
1. The risk is defined as the situation of winning or losing something
worthy. Uncertainty is a condition where there is no knowledge about the
future events.
2. Risk can be measured and quantified, through theoretical models.
Conversely, it is not possible to measure uncertainty in quantitative terms,
as the future events are unpredictable.
3. The potential outcomes are known in risk, whereas in the case of
uncertainty, the outcomes are unknown.
4. Risk can be controlled if proper measures are taken to control it. On the
other hand, uncertainty is beyond the control of the person or enterprise,
as the future is uncertain.
5. Minimization of risk can be done, by taking necessary precautions. As
opposed to the uncertainty that cannot be minimised.
6. In risk, probabilities are assigned to a set of circumstances which is not
possible in case of uncertainty.

Risk And Return Of A Portfolio

 One of the ideal measures to reduce risk while
simultaneously maximizing revenue is by diversifying the investment
portfolio. Investors can choose multiple investments that offer different
returns accordingly.
There are different investment options:
stocks, bonds, commodities, mutual funds, etc. Stocks usually carry
high chance of failure but can give good returns. On the other
hand, government bonds can carry low to zero risk but offer low profits.
There are many benefits of diversifying an investment portfolio. Investors
can choose to invest in stocks with high risk and compensate for the risk
by investing in bonds. Bonds usually give assured returns, although it is
low. They can also invest in mutual funds for a longer period with
moderate risk.
In studying the risk and return concept, some financial experts suggest
investing in different industries or markets. Because different sectors
prosper and fall at different times. For example, during the onset of the
COVID-19 pandemic, many internet and e-commerce companies
flourished, whereas automobile companies didn’t do well. So, taking
different investment stands can help investors in the long run.
Types
The risk and return analysis is an important concept in the financial
market. Both 0o them can be categorized as follows:
Types Of Risk
 Market risk – It is also called systematic risk and arise due to various
market related factors like economic and political problems, interest rate
and currency fluctuations, etc. They have a huge impact on the investors.
 Specific risks – They are related mostly to company itself. They may be
controlled through diversification an monitoring.
 Credit risk – This is related to credit worthiness of the company or
business. If the financial condition of the business is good, it will be able
to meet its current and future obligations and repay its debts on time. This
will lead to good credit rating. Credit risk is the result of deteriorating
financial health of the company.
 Liquidity risk – This is the result of the business not being able to earn
good revenue to meet its financial obligations and maintain high working
capital.
 Interest rate risk – The fluctuations in the interest rates in an economy
can affect the business’s borrowing capacity.
  Inflation – The inflation leads to erosion of value of investments and the
value of cash flows in future.

Types Of Return
 Capital gains – Any good investment will rise in value as time passes by.
Thus the assets will be valued higher if they are sold later on as compared
to its purchase price, giving capital gain.
 Dividends – they are a steady source of income for investors who invest
in shares of companies giving regular dividends which are a part of the
profits set aside for investors.
 Interest – Borrowers like individuals or corporates borrow money for
meeting expenses or capital requirements. The lenders give the funds to
get interest on the principal amount which is a return on investment for
the lenders.
 Rental income – Any property rented out can earn rent on a regular
basis, which is also a return in the real estate property.
 Return from currency trading – Profits earned from trading in
exchange rates by using the differences is exchange rate of different
currency is also a form of return for those who do currency trading.