Characterizing Risk and Return, Thesis of Financial Accounting

Download Characterizing Risk and Return and more Thesis Financial Accounting in PDF only on Docsity!

Characterizing Risk and Return

Capella University

BUS-FP

Characterizing Risk and Return

1. Investment risk refers to uncertainties investors are ready and willing to shoulder to

realize gains from an investment (Wall Street mojo, 2020).Finance and investments are the

probability of having actual results differing from the expected results or earnings, categorized as

systemic or non-systemic. Systemic risks deal with an investment market's uncertainty but un-

systemic consists of uncertainties that affect investment performance but are asset-specific.

Measures of risks are statistical formulae and tools used to assess the risks involved in business

investments.

Risks are measured by quantifying volatility, which is the differencebetween actual and

average/expected returns. The resultant difference is the standard deviation, which defines the

expected range of returns from an investment. Generally, the risk is measured by standard

deviation, beta coefficient, conditional value at risk, or value.

2. Firm-specific risk are risks that involve a particular company or firm due to some

business issues that impact the firm or industry-leading to uncertainties. We can refer to the

portion of the total risk attributable to a specific firm or industry factors. Sources of this risk

include poor management decisions, a new competitor's entrance, and technology

changes.Marketrisks are a portion of the total risk attributable to general economic factors (Hue,

Jinks, Spain, Bora, & Siew, 2019). Sources of market risks are recessions and depressions,

political uprising, interest rate changes, natural calamities, and terrorism. This can lead to

volatile interest rates, risky foreign exchange, uncertain equity pricing, and commodities risk.

3. The coefficient of variation is used to measure the risk associated with an investment

and is simply a ratio of the standard deviation to mean or expected cash flow. It enables investors

to quantify the volatility assumed concerning expected returns. A lower coefficient of variation

Conglomco has an average return of 11 percent and a standard deviation of 24 percent.

CV

× =¿

Supercorp has an average return of 16 percent and a standard deviation of 37 percent.

CV

Megaorg has an average return of 10 percent and a standard deviation of 29 percent.

CV¿ 29 / 10 =2.90 %

Ranking by total risk profile.

Megaorg, followed by supercorp, and finally, conglomco has the lowest risk.

Year-to-date, Conglomco has earned a −1.64 percent return, Supercorp has earned a 5.69 percent

return, and Megaorg has earned a 0.23 percent return. If your portfolio is made up of 40 percent

Conglomco stock, 30 percent Supercorp stock, and 30 percent Megaorg stock, what is your

portfolio return?

When computing portfolio expected Return, investor’s first compute expected Return of

every security and their weights in the portfolio. Then multiplies expected Return by specific

weight and sums up the results.

Expected Return ¿ w 1 × R 1 + W 2 × R 2 + W 3 × R 3

W

1

is the weight of the conglomco, W2 is the weight of the supercorp, and W3 is the

weight of megaorg.

ER

× −1.64+

×

× 0.23=−0.656+ 1.707+0.069=1.12%

References