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The risk-return spectrum is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment.[citation needed] The more return sought, the more risk that must be undertaken

Investment Objective:

Introduction to investment objective

Meaning of investment objective :

An investment objective mostly comes in the form of a survey which contains client information like risk aversion, current liquid and net worth, income and expense levels and  time frame for investment.

The ultimate investment objective is to maximize the value of the investors’ portfolio. The risk and return on investments are directly related and so it is not appropriate for an investor to say that the investment objective is to ‘accumulate a lot of wealth’. Rather he/she should state that the objective is to increase wealth while recognizing that there are possibilities of incurring losses.

Features of Investment Objectives :

Investment objectives mostly reflect the returns of investment and the risk involved in the investment. The higher the risk involved, the greater the expected returns and vice-versa.

The objective depends on the investor’s need and the time he is willing to lock in his money.

A successful investment strategy requires sound investment objectives. Portfolio managers and fund managers associated with mutual funds and other fund investments take due care to tailor the portfolio so as to match the investment and attain the desired objective in the stated time frame of the investment. Tailoring a portfolio that matches a specific objective involves complex mathematical calculations that are normally done by the fund managers or the portfolio managers responsible for the creation of the portfolio. Investments are normally made in the money market which typically includes securities like commercial paper, treasury bills, certificate of deposit, government bond, corporate bonds, etc. Every investment can be categorized according to the 3 basic features – safety, income and growth. 

Investment Objectives, an Art or Science?

Setting an investment objective is widely regarded both an art and science and setting objectives can also imply making a lot of trade offs.

Thus, your investment objectives should be in line with the investor’s specific needs, level of risk and the time for which the money is locked in.

Pricing Model Formula

Introduction:

Pricing model is used to resolve appropriately required rate of return of an asset. This model involves in calculating the assets account that is sensible to market risk which is represented using beta (β) in the financial industries.

                Jack Treynor, William Sharpe, John Lintner and Jan Mossin introduced this pricing model formula. Sharpe, Markowitz and Merton Miller jointly got the Nobel Memorial Prize for this pricing model.

Explanation:

Explanation:

               Pricing model is a model used to calculate the price of an individual security. While dealing with individual security, we should make use of the security market line and their relationship to the returned asset and market risk to indicate the market risk in relationship to the security risk class. In the pricing model, security market line enables us to compute the reward-to-risk ratio in relationship to that of the market.

               So that, the expected rate of return is depressed by its beta coefficient, the reward-to-risk ratio for any individual security in the market is equal to the market reward-to-risk ratio.

The formula for calculating pricing model is,

calculating risk pricing model


By rearranging the above equation, we get the pricing formula as

 risk pricing formula

Where

  •          capital assetis the expected return on the capital asset
  •             img      is the risk-free rate of interest
  •   beta co-efficient is the expected excess asset returns

 to the expected excess market returns, or also ,risk free rate of interest

  •          capital asset using the pricing modelis the expected return of the market
  •                  imgis  the risk premium

Example:

Example 1:

Calculate the value of expected return on the capital asset using the pricing model

Where Rf  = 1 E( Rm) = 2  img = 1

Using the pricing model formula, we get

=  1 + 1( 2 - 1)

=2

Example 2:

Calculate the value of expected return on the capital asset using the pricing model

Where Rf  = 2 E(Rm) = 4 return on the capital asset=1

Using the pricing model formula, we get

= 2 + 1 ( 4 - 2)

= 4


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