This is know as the beta co-efficient of the security. That means, the return on a
security depends on the risk measured by this beta.
The risk of investment in each security in terms of variations may be calculated in
terms of percentage and then one security may be compared with the other. Such
comparison may help the investor to decide how much he has to invest and in which
security.
The expected return on each security may be arrived by means of weighted average.
The comparison of estimation of risk and return of each security will place an
investor in a better position to decide the purchase of each quantum of
security, or not to make a purchase etc. The important point is that inspite
of all such efforts regarding diversified investment one cannot reduce the
risk to zero. The reality is that one has to accept the margin of market risk
or non-diversifiable risk. The selected number of securities from the
different industries is sufficient to analyze a market portfolio.The non-diversifiable risk or market risk may involve with risk associated with the
fluctuations in the market index itself. The diversification will not eliminate the
market risk.
We know that risks are of two types, (i) Diversifiable risk, and (ii) Non-diversifiable
risk
Diversification of investments within an industry and diversification across several
industries are of two different types. But the focus will on the same i.e., reduction of
risk.
The non-diversifiable risk is also called as unavoidable risk and such risks cannot be
diversified, because the entire market will be affected by one factor for e.g., common
fiscal policy.
CAP-M (Capital Asset Pricing Model)
We know that an investor always tries to choose a security with low risk and high
return. Before investment, the decision to invest is based only on
estimations. To reduce risks, one will invest in securities of different
firms in a industry or industries. The combination of securities that one
would like to purchase will be influenced by the dominance principle.
This has to be worked in various proportions of risk and returns on
securities. Based on this, an ‘opportunity site’ has to be formed by
incorporating all the select securities in a portfolio. The Opportunity site
has two layers, upper layer and a lower layer. The securities showing the
combination return and risk below a lower layer of opportunity site will
not be considered by an investor. The best choice to invest in securities
depending on the combination of risk and returns lies between the upper