Business Finance Homework Help

post 1 : Risk implies uncertainty. This essentially implies the risk of losing investment or the investment will potentially yield less than its expected returns. Risk actually measures the degree of probability that an investment will either make or lose money. There are two critical factors to understand when determining investment risks; first, the capacity of an investor to tolerate risk itself, and second, the risk of the investment itself. Risk and return are closely linked in that, in order to gain a return, when an investor decides to make an investment, they genuinely intend to make money on it. Thus, the greater the risk, the greater the opportunity for return, but also the greater the risk of failure associated with it. Standard deviation, beta, value at risk (VaR), conditional value at risk (CVaR), R-squared, etc. are some typical risk measures.

Standard deviation is the most common risk measure. An absolute type of risk measure is the standard deviation; it is not calculated in relation to other assets or market returns. The distribution of returns across the average return calculates the standard deviation. In making an investment decision, the standard deviation is used to calculate the amount of historical uncertainty associated with an investment compared to its annual rate of return. It shows how far the present return deviates from its predicted natural historical return (Segal, 2020). For example, higher volatility is experienced by a stock that has a high standard deviation, and thus a higher risk level is associated with the stock. A higher standard deviation means that in annual returns, the investor holding the asset will face greater volatility (Brealey et. al., 2020). In exchange for this confusion, investors expect higher returns. Higher risk and higher annual returns are usually correlated with equity securities (stocks). Usually, fixed income securities (bonds) show lower standard deviations than equity securities and generally gain lower annual average returns (Wespath, 2016). As far as investment is concerned, for example, the index fund is expected to have a low standard deviation from its benchmark index, as the purpose of the fund is to repeat the index. Standard deviation is one of the main risk-based metrics used by analysts, portfolio managers, and advisors (Hargrave, 2020). Investment companies record a standard deviation for their mutual funds and other goods (Brealey et. al., 2020).

post 2:Market risk cannot be completely removed irrespective of the number of stocks an investor owns but it is possible to assess a stock’s past response to market fluctuations and choose to invest in stocks with a volatility level that is comfortable for a particular investor. Beta and standard deviation are two widely used techniques for assessing stock risk. For this discussion, I would like to describe beta in detail (WiserAdvisor, n.d.).

Because risk depends on exposure to macroeconomic events, we measure risk of individual common stocks as the sensitivity of a stock’s returns to fluctuations in returns on the market portfolio and this sensitivity is called the stock’s beta (Brealey, Myers, & Marcus, 2020). Beta is a statistical measure of the impact stock market moves have historically had on a stock’s price and the beta estimates can be found in several published services like finance.yahoo.com. A pattern emerges when the returns of the Standard & Poor’s 500 (S&P 500) are compared to the returns of a specific stock. This pattern reflects the stock’s susceptibility to stock market risk. The S&P 5000 is an unmanaged index with a beta of 1 that is often considered to be reflective of the US stock market (WiserAdvisor, n.d.). A stock with a beta of 1 moves in consonance with the S&P 500, the stock rising 10% when the S&P climbs 10% and vice versa. While a beta of larger than one suggests that the stock should rise or fall more than stock market movements, a beta of less than one indicates that the stock should rise or fall less than the S&P 500. A perfect correlation cannot be expected with each market change because beta gauges average market movements.

The beta of a portfolio will provide an investor with a sense of its overall market risk. To achieve this, the betas of all the stocks can be calculated first and then the beta of each stock is multiplied by the percentage of the whole portfolio it represents. For example, a stock with a beta of 1.2 that makes up 10 percent of the portfolio would have a weighted beta of 1.2 times 10 percent or 0.12 (WiserAdvisor, n.d.). All the weighted betas are added together to get the portfolio’s overall beta.