Part 30. Risk and profitability: myths and truth, or income as a fee for risk

Once, many years ago, I was an investment banker. Then I led Internet business, created Internet startups, designed the mechanisms of state support for innovation. And everywhere I had to make financial models of new projects from scratch. I did not compose financial models only at two stages of my life: when I was a business journalist and when I taught Fiztekh students. But in these periods of my life, I learned to write about what I know for myself, and teach financial modeling to those who know a little about him. This course is the result of all three parts of my life. Successful study!

The risk of investment and the required profitability from them are connected by direct relationship. As the risk of investment increases, the expected income is growing. We examined this ratio on the example of a portfolio of a venture company in the chapter “Venture Fund portfolio: what startups are needed by professional investors”. It should not be considered that this ratio is observed only for direct investments of the highest risk class - it acts for any investment situations.

What do we know about risk and its nature? Empiric observation of risk and profitability explains the theory of CAPM (Capital Asset Pricing Model - a model of pricing of capital assets) and APT (Arbitrage Pricing Theory - arbitration pricing).

Arbitration - extracting income from the difference in the price of the asset in different markets.

In the practice of financial modeling, we most likely do not have to resort to calculation of indicators according to these models, so we focus on how exactly they interpret the very concept of risk.

The CAPM model, which arose in the 1960s, considers the risk as a “black box”-in it it is a certain external constant.

Suppose that RF is a risk -free yield, that is, the minimum profitability of any investment market, RM is the current profitability of investment in the whole market, Ri is the required return on a certain asset I. According to CAPM, the expected profitability of the asset can be expressed by the following linear ratio:

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