FIN 6160 CMU Managerial Finan

Learning Engagement # 3

TOPIC: Whether risk of a security/stock is same in isolation and 
          as a part of a portfolio?

PROFESSOR’S GUIDANCE FOR THIS WEEK’S LE:

An investor may hold a security in isolation or he/she may hold it as a part of a portfolio. What impact it may have as to the risk exposure of the investor holding that security? How do you define risk of a security? How do you define risk of a portfolio?

by Jana Kmetova

According to Abhishek (2018), seven kinds of risk are connected with security. Firstly, market risk – this kind of risk is also called systematic risk, and it is based on daily fluctuation in the market. The market values go up and down during a day, affecting the returns from the stocks. For instance, if the market values go down at a time, then stock prices go down. In addition, short-term risks are higher compared to long-term. The second risk of the stock/security is a business risk – this risk comes from business and can increase if the company is doing well. The crucial reasons for risk increase are poor leadership and quarter-by-quarter results or misjudgment in bringing a company under business risk. Thirdly, liquidity risk – the higher the debt is, the higher the risk of the company to pay its bills increases. When the risk is too high, many companies come with the solution of cutting their dividends. Following is taxability risk – taxes change all the time, and taxation can affect the stock price. Since the government controls taxation, there is nothing much that management can do to influence the evolution of the prices.
Furthermore, the global market changes interest rates sometimes, which brings interest rate risk for the companies. For example, if the interest rates are high, the company has difficulties borrowing the money. Regulatory risk is another kind of danger for stocks on the market. For example, suppose a company loses a license to make alcoholic beverages. In that case, it will influence the profit and stick of the company because many companies are highly regulated by the government, such as tobacco factories, pharmaceutical or cosmetics companies. The last risk is an inflationary risk – if inflation increases, the raw material increases, and production costs. Moreover, it is worth mentioning that there are more risks such as credit, political, and exchange risks that can influence the stocks on the market.
On the other hand, portfolio risk is defined as the probability of the assets that the company holds sinking, which is caused by significant loss to the company in the meaning of its investment being lost (CFaJOURNAL, N/A). According to Washington (2020), the types of risk management are external (such as – political influence, recession, regulatory changes, legal requirements), internal such as (operation challenges, leadership changes, portfolio governance, financial health); and execution-related risks (such as project risk, resource capacity risk or project dependencies).

Resources:
Abhishek K. (2018, February 26). 7 Types of Risk Involved in Stocks that You Should Know, https://tradebrains.in/types-risk-involved-in-stoc…

CFaJOURNAL. (N/A). What is Portfolio Risk, and how is it calculated? https://www.cfajournal.org/portfolio-risk/

Washington T. (2020, May 4). PPM 101 – Portfolio Risk Management, https://acuityppm.com/ppm-101-portfolioriskmanagem…

by Ngoc DinhLearning Engagement # 3

TOPIC: Whether risk of a security/stock is same in isolation and
as a part of a portfolio?

The risk of the asset held in isolation is not relevant under the CAPM. According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. All financial assets can be examined in the context of a broader portfolio or on a stand-alone basis when the asset in question is thought to be isolated. For a company, computing standalone risk can help determine a project’s risk as if it were operating as an independent entity. Thus, the relevant risk of a stock is the stock’s contribution to the riskiness of a well-diversified portfolio (Chen, 2020).

Although it is often used in different contexts, risk is the possibility that an outcome will not be as expected, specifically in reference to returns on investment in finance. However, there are several different kinds of risk, including investment risk, market risk, inflation risk, business risk, liquidity risk, and more. Generally, individuals, companies, or countries incur the risk that they may lose some or of an investment (Sraders, 2019).

An investor may hold a security in isolation or he/she may hold it as a part of a portfolio. What impact it may have as to the risk exposure of the investor holding that security?

Investors who hold a stock for a long period of time can benefit from quarterly dividends and potential price appreciation over time. Even if a stock is given a hold recommendation and remains flat, if it pays a dividend, the investor can still profit. For fundamental investors, it is generally better to hold stocks for the long term, meaning at least months and preferably a decent number of years. Holding stocks for short time periods is considered speculating rather than investing and will essentially increase your risk of losing money in the long run (Sutherland, 2012).

On the other hand, having too much stock equals extra expense for you as it can lead to a shortfall in your cash flow and incur excess storage costs. Having too little stock equals lost income in the form of lost sales, while also undermining customer confidence in your ability to supply the products you claim to sell.

How do you define risk of a security?

Risk of a security/stock is when a company doesn’t do well or falls out of favor with investors, its stock can fall in price, and investors could lose money. Whether it be the risk of an accelerated inflation rate or a volatile stock, risk is a huge factor to examine and understand when getting into the market (or even as a business or corporation). And in recent years, with trade wars and questionable interest rates, it seems as though risk may be more of a prevalent topic when it comes to placing your money in an investment vehicle – or even starting a business (Nikolas, 2020).

Beta and standard deviation are two tools commonly used to measure stock risk. Beta, which can be found in several published services, is a statistical measure of the impact stock market movements have historically had on a stock’s price.

How do you define risk of a portfolio?

Portfolio risk is a chance that the combination of assets or units, within the investments that you own, fails to meet financial objectives. Each investment within a portfolio carries its own risk, with a higher potential return typically meaning higher risk. In theory, portfolio risk can be eliminated by successful diversification: holding combinations of investments that do not depend on the same circumstances to return a profit. Though, it is more probable that risks will be minimized and not eliminated entirely.

The most important quality of portfolio variance is that its value is a weighted combination of the individual variances of each of the assets adjusted by their covariances. This means that the overall portfolio variance is lower than a simple weighted average of the individual variances of the stocks in the portfolio (Hayes, 2021).

How do you calculate portfolio risk? The level of risk in a portfolio is often measured using standard deviation, which is calculated as the square root of the variance. If data points are far away from the mean, the variance is high, and the overall level of risk in the portfolio is high as well.

The formula for portfolio variance in a two-asset portfolio is as follows:

Portfolio variance = w12?12 + w22?22 + 2w1w2Cov1,2

When considering your investment risk tolerance, some simple rules to consider are:

-The greater return you want, the more risk you’ll usually have to accept.

-The higher return you want from your investments, the greater the chance of losing some or all of your initial investment (your capital) in the short term.

-If you’re saving over the short term it’s wise not to take much capital risk. So, what you are investing for and when you’ll need access to your money will have a big impact on what types of investments are right for you.

-If you are investing for the long-term you can afford to take more risks.

Investing in share-based assets has proved to be the best way of achieving growth that outstrips inflation. There is a risk attached but when you invest over the long-term, you gain time to recover your losses after the inevitable and never-ending market correction periods (Sutherland, 2012).

References.

Chen, J. (2020). Standalone Risk. Trading Skills & Essentials. Risk Management, Investopedia.

Hayes, A. (2021). Portfolio Variance. Trading Skills & Essentials. Risk Management. Investopedia

Nikolas, S. (2020). How does market risk differ from specific risk? Trading Skills & Essentials. Investopedia.

Sutherland, S. (2012). 5 key factors that can affect your investment risk tolerance. ISACO, Ltd.

Sraders, A. (2019). What Is Risk? Definition, Types and Examples. TheStreets., Inc.

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FIN 6160 CMU Managerial Finan

I’m working on a economics project and need support to help me learn.

Case Study:

Hand in an excel sheet for the following:

Calculate monthly beta for Apple.

Use monthly return for Apple between June 1 2015 to June 1 2020. USE S&P return as market return.

For data look at yahoo finance web site.

Watch this video for help but don’t copy it blindly. You need to understand it and apply it to your case.

Please contact me if you have any questions.

Substance of the Assignment

0-35: The paper was not written to the writing prompt and remained in the domain of the subject matter. Less than 750 words.
36-43: The paper was somewhat written to the writing prompt and remained in the domain of the subject matter. 750 -1,000 words minimum.
44-50: The paper was written to the writing prompt and remained in the domain of the subject matter. 750 -1,000 words minimum.

50

Organization of the applied project

0-6: The structure and pattern of the paper is incomprehensible.
7-8: The structure and pattern of the paper is unclear, has some organization, but has a good logical flow. Most paragraphs are well developed and there are transitions between paragraphs.
9-10: The structure and pattern of the paper is clear, organized, and has a logical flow. Each paragraph is well developed and there is a good transition between paragraphs.

10

Mechanics of writing

0-6: Student’s paper has more than ten errors in spelling, punctuation, and grammar.
7-8: Student’s paper has less than ten errors in spelling, punctuation, and grammar.
9-10: Student’s paper has less than six errors in spelling, punctuation, and grammar.

10

Evidence of research

0-16: The student’s paper is not supported with at least 1 scholarly peer reviewed academic resources and there are no citations in APA format.
17-18: Some of the student’s paper is supported with at least 2 -scholarly peer reviewed academic resource, which is correctly cited in APA format.
19-20: The student’s paper is supported with at least 2 – 3 scholarly peer reviewed academic resources, which are correctly cited in APA format.

20

Length of paper

0-7: Students paper did not meet the paper length requirement.
8: Student’s paper was two or less pages under the required paper length for their degree level.
9-10: Student has met the paper length requirement for their degree level.

10

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