Risk and Return Profile of Securities
Added on 2020-01-06
29 Pages6957 Words55 ViewsType: 55
Finance
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CORPORATE FINANCE1
TABLE OF CONTENTSQUESTION 1.......................................................................................................................................3A) Calculation of annualized return.................................................................................................3B) Reasons for differences in risk and return profile of securities..................................................4C) Graphical presentation................................................................................................................4D) Re-calculation of risk and returns of two set portfolio at two different correlation coefficient 6E) Understanding of risk and return and the importance of correlation coefficient........................7QUESTION 2.......................................................................................................................................8A) (1) Computation of future value ................................................................................................82. Calculation of present value........................................................................................................93. Appropriate decisions..................................................................................................................92(B) Required calculations............................................................................................................10(1) ..................................................................................................................................................10(2) ..................................................................................................................................................10(3) ..................................................................................................................................................10(4)...................................................................................................................................................112(C) (1) Behavioural finance concepts..........................................................................................11(2) Discuss how an investor practices traditional finance to challenge each three concepts.........12QUESTION 3.....................................................................................................................................12REFERENCES...................................................................................................................................14APPENDIX........................................................................................................................................162
INDEX OF TABLESTable 1: Calculation of annualised return ............................................................................................4Table 2: Calculation of portfolio risk and return .................................................................................7Table 3: Calculation of portfolio risk and return .................................................................................8Table 4: Calculation of monthly instalments .....................................................................................11Table 5: Calculations of monthly payment after re-finance ..............................................................11Table 6: Calculation to pay the mortgage after re-finance ................................................................12Table 7: Calculation of additional cash need to borrow as re-financing ...........................................123
QUESTION 1Portfolio theory is a quantitative analysis which demonstrates the way in which an investorcan diversify their investment portfolio so as to minimize their risk and maximize returns. With thehelp of this, capitalists can decide an optimum portfolio which will yield higher returns to them.This theory comprises of four facets that are valuation of individual security by making risk andreturn evaluation, assets allocation, portfolio optimization and performance measurement (Byers,Groth and Sakao, 2015). According to the theory, share capital expected return includes bothdividend and capital appreciation (increase in stock price). However, yield on debt instrumentcomprises of capital appreciation due to fall in interest rate, timely instalment payments andrepayment of principal amount at the time of maturity. On contrary to this, risk indicates thepossibility of variability in return which is highly based upon historical volatility (Thompson,2016). This theory states that investors can hold a diversified portfolio by investing funds indifferent securities in which the possibility of risk and return is different. By this, investor can makequalitative decisions in order to get higher returns on investment (Chen, 2016). This task will makerisk and return analysis that is associated in a low cost airline, Zoom Plc., national chain of highstreet cafes and bistros, Munch Plc., Market Index and three-month government bills as well. A) Calculation of annualized returnAs name implies, the amount of profit which an investor can earn on their securities duringone year is called as an annualised return (Altman and et.al., 2014). It is important for an investor todetermine the possibility of yield on their potential investment. Formula: Table 1: Calculation of annualised return Calculation of annualised return Particular Zoom Plc.Munch Plc.Market Index3 monthsGovernment bill Monthly return 2.25%1.25%0.90%0.30%Number of months12121212Annualized return 30.60%16.08%11.35%3.66%Taking into account the results, it can be seen that annualized returns for Zoom Plc. is4
comparatively greater to 30.60%. However, in Munch Plc., Market Index and 3-month governmentbills, yield possibilities are 16.08%, 11.35% and 3.66% respectively. Henceforth, it can be said thatinvestment in Zoom Plc. will deliver higher returns to the potential investors as compared to othersecurities. Although, it provides a basic idea about future returns, but still, it has several limitation.One of the most important drawback is, it cannot be ensured that money can be reinvested at samerate of interest in the next month. It may either increase or decrease over the next period. Thus, insuch a case, it does not provide realistic and valid results to the investors. B) Reasons for differences in risk and return profile of securitiesRisk indicates the possibility that actual returns of security may be lower than expectedhowever, return is the chance of future profit or yield on securities. In other words, variability inanticipated return represents the total risk involved in securities (Kresta and Tichy, 2012). Withrespect to the scenario, individual and market risk and return profile are affected by the externalvolatility such as economic recession, inflation, political instability, industrial growth, scams,changes in government policies and interest rate. However, on the other hand, securitiesunsystematic risk comprises factors like business performance, managerial inefficiency, scarcity ofresource, strike, financial difficulties and uncertainty. Besides this, it is also influenced by the rateof dividend and capital gain as well (Shim, 2013). On the contrary, government bill prices areaffected by the economic conditions, supply and demand forces as well as through monetary policy.C) Graphical presentationFormula of portfolio return = (W1*E(r1)+W2*E(r2)Formula of portfolio risk (Standard deviation)= √[(W1)^2*(std. Dev. 1)^2 + (W2)^2*(std. Dev.)^2 + (2*w1*w2*std. Dev.1*std. Dev.2*correlation between both the securities)5
Table 2: Calculation of portfolio risk and returnPortfolio risk and returnPortfolio Weight in Zoom Plc.Weight in MunchPlc.Portfolioreturn Portfolio standarddeviationA 0.00%100.00%16.08%9.50%B20.00%80.00%18.98%12.47%C 40.00%60.00%21.89%17.67%D60.00%40.00%24.79%23.68%E80.00%20.00%27.70%30.01%F100.00%0.00%30.60%36.50%Return 30.60%16.08%Standarddeviation 36.50%9.50%Correlation 0.46
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