Risk Return Consideration in Finance

FINANCE
ACC00716
STUDENT ID:
[Pick the date]

Question 1
a) $1,094,117.28
b) $720.26 million
c) 5.55%
d) $12,670.25
e) 5.36%
f) $35
Question 2
a) The key aim is to estimate the returns that the equity investors of given companies would
expect on the underlying shares. In this regards, an appropriate approach is provided by
Capital Asset Pricing Model. The mathematical representation of this model is captured
suing the equation highlighted below (Ross et. al., 2015).
Expected return on equity shares = Risk free Rate + Beta * Risk Premium of Market
(i) Some of the inputs required to compute the expected returns have been provided such as
market risk premium (6 percent). The data source used to derive the other information
such as risk free rate and beta of the selected company (i.e. MYOB) is S&P Capital IQ
database.
CAPM Model
The returns expected by MYOB ?
Risk Free rate 1.91% p.a.
Beta 0.36
Risk Premium of Market 4.07
Expected return on equity shares = {1.91 + (0.36 * 6)} = 4.07%
(i) For a hypothetical company
CAPM Model
The returns expected by a hypothetical
company
?
Risk Free rate proxy 1.91% p.a.

(10years Australian bonds)
Beta -0.20
Risk Premium of Market 6
Expected return on equity shares = {1.91 + (-0.20 * 6)} = 0.71%
PART B
As per the information provided, a portfolio has been formed with the above two companies
with equal representation from each company.
Portfolio (Expected Returns) ¿ 4.07∗(1
2 )+0.71∗( 1
2 )=2.39 %
Portfolio (Expected Beta) ¿ 0.36∗( 1
2 )+−0.2∗(1
2 )=0.08
Question 3
Risk Return Consideration
A noteworthy aspect with regards to portfolio investment is that the asset allocation must not
be performed on the basis of one of the parameters i.e. risk and return. This may be
misleading and lead the investor into making sub-optimal choices. For instance, if two
investment opportunities having beta of 1.4 and 2.4 are compared and the opportunity with
the lower beta is selected driven by the endeavour to lower risk would lead to wrong
decision. The key aspect which Modern Portfolio Theory (MPT) highlights is that risk and
return must not be looked at in isolation owing to the underlying relationship between them.
To highlight this relation, Henry Markowitz has highlighted the assumption that humans tend
to behave rationally and are risk averse (Damodaran, 2015). The fact that investors are risk
averse would imply that if they are offered investment choices with similar returns, they
would tend to choose the one which offers the lowest amount of risk. The investors would
only assume a higher amount of risk when some reward is provided to them in the form of
higher returns. Driven by the potential of these superior returns, the investors may take
position in risky stocks. This clearly highlights that risk and returns tend to be interrelated. As
a result, usually risky assets would lead to higher amount of returns which is essential so that
investors tend to show buying interest in these assets (Brealey, Myers and Allen, 2014).