Investment risk
Investment risk

Start this free course now. Just create an account and sign in. Enrol and complete the course for a free statement of participation or digital badge if available.

Free course

Investment risk

2 Quantifying risk

2.1 Looking at each of the possible alternative outcomes

Investment risk is synonymous with uncertainty of outcome, so it is logical to try to quantify risk by looking at the relative uncertainty, or probability, of each of the possible alternative outcomes.

Suppose that we are interested in investing in the shares of Company X, and want to know:

  • What is the mean or average expected total return for the next year?

  • What is the degree of risk or uncertainty in this mean figure?

We might begin by collecting and tabulating data about total returns on the same company's shares for each of the past 50 years. In order to make this example easy to follow, we shall keep the data very simple, but the same principles apply to the more complex patterns of data derived from real-life studies. The simplified table might look like Table 1.

Table 1 Frequency distribution of the actual total returns on a one-year investment in shares of Company X in each of the last 50 years

Total return (% per annum)Frequency of occurrenceProbability
4%100.2
6%150.3
8%150.3
10%100.2
Totals501.0

What can we say about next year's total return on an investment in shares of Company X? If the fundamental factors determining the share's performance are unchanged – and that is a very big ‘if’ indeed – we can convert these long-run frequencies of past returns into probabilities concerning the future. The big question – whether the future is an extension of the past – is one to which we shall return later.

B821_1

Take your learning further

Making the decision to study can be a big step, which is why you'll want a trusted University. The Open University has 50 years’ experience delivering flexible learning and 170,000 students are studying with us right now. Take a look at all Open University courses.

If you are new to University-level study, we offer two introductory routes to our qualifications. You could either choose to start with an Access module, or a module which allows you to count your previous learning towards an Open University qualification. Read our guide on Where to take your learning next for more information.

Not ready for formal University study? Then browse over 1000 free courses on OpenLearn and sign up to our newsletter to hear about new free courses as they are released.

Every year, thousands of students decide to study with The Open University. With over 120 qualifications, we’ve got the right course for you.

Request an Open University prospectus371