Finance: Risks and Returns Analysis

This article analyzes the risks and returns associated with the business of MYOB and provides insights into systematic and unsystematic risks. It also discusses the application of the Capital Asset Pricing Model (CAPM) and the implications of systematic and unsystematic risks. The article includes a graphical representation of the Security Market Line (SML) and concludes with the importance of portfolio diversification.

Running head: FINANCE
Finance
Name of the Student:
Name of the University:
Author’s Note:

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Table of Contents
Requirements to Question 1a...........................................................................................................2
Requirements to Question 1b...........................................................................................................2
Requirements to Question 1c...........................................................................................................2
Requirements to Question 1d...........................................................................................................2
Requirements to Question 1e...........................................................................................................3
Requirements to Question 1f...........................................................................................................3
Requirements to Question 2a...........................................................................................................3
Requirements to Question 2b...........................................................................................................4
Requirement to Question 3a............................................................................................................4
Introduction..................................................................................................................................4
Capital Asset Pricing Model (CAPM) Theory............................................................................5
Implications of Systematic and Unsystematic risks....................................................................6
SML Line.....................................................................................................................................6
Conclusion.......................................................................................................................................8
Reference.........................................................................................................................................9

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Requirements to Question 1a
Requirements to Question 1b
Requirements to Question 1c
Requirements to Question 1d

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Requirements to Question 1e
Requirements to Question 1f
Requirements to Question 2a

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Requirements to Question 2b
Requirement to Question 3a
Introduction
The main purpose of this part is to analyze the business of MYOB which is engaged in
the business of trading shares. The analysis is conducted for ascertaining the measures for risks
and returns estimates for the business. The analysis which is conducted is appropriate and the
same effectively highlights theories and formulas that are applied by users while selecting
appropriate stocks for investment purpose. The investors also consider the information which is
available on systematic and unsystematic risks so that their scope for investment can be
improved significantly. In addition to this a detailed evaluation of the portfolio is conducted so
that the impact of the investment decisions can be estimated clearly (Bromiley et al. 2015). The
analysis which is presented below also shows graphical presentation of CAPM formula in
Security Market line. This effectively shows whether appropriate formula is applied in assessing
the risks and returns which are associated with the concerned portfolio.

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Capital Asset Pricing Model (CAPM) Theory
The application of CAPM model is done by investors so that appropriate decisions can be
taken regarding the investment strategy of the investor considering the objectives and goals of
the investors. CAPM model is considered to be one of the most useful tool for an investor for
assessing the risks and returns which is associated with a portfolio (Džaja and Aljinović 2013).
An investor can take decisions based in the results which are obtained by applying CAPM model
on an investment. The formula which is applied in case of CAPM model is depicted below:
Figure 1: CAPM formula
(Source: Zabarankin, Pavlikov and Uryasev 2014)
The formula which is depicted above shows expected return from the stock, market return
of the stock and also risk-free rate of return from the stock. In addition to this, the formula also
considers Beta (B1) which represents the risks factor which is associated with the stock. CAPM
model is applied by investors for establishing a relationship between systematic risks and
expected returns which is associated with the stock (Francis and Kim 2013). The CAPM
approach is used by businesses for pricing securities which are risky in nature. In addition to this,
it is to be noted that the CAPM approach considers certain assumptions and one of the major
assumption which is considered by the approach is that the investor maintains a fully diversified

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portfolio which also suggest that the investor is expecting returns considering systematic risks
and not the total risk associated with the stock (Acheampong and Agalega 2013). The main
benefits of CAPM method is for the investors as they can effectively use the method for creating
an appropriate portfolio which comprises of both low risk and high-risk stocks.
Implications of Systematic and Unsystematic risks
Whenever an investor is thinking about making investments then he should always take
into account the systematic and unsystematic risks which is associated with the investment
(Anjum 2014). It is to be noted that by considering both the type of risks, an investor can the
make a call on how much risk can be diversified in order to minimize the total risks which is
associated with the investment (Ahuja 2015). One of the major tool which is used by investors
for spreading out the risks and ensuring that no negative impact of the investment befalls them is
diversification (Darolles, Gouriéroux and Jay 2015). Another important tool which is available to
an investor is hedging techniques which can be effectively used by the investor for diversifying
unsystematic risks which is associated with the investment. Similarly, a very high systematic risk
is also not appropriate as it can have a direct impact on the investment capital of the investor.
SML Line

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Figure 2: Security Market Line
Source: (Created by the Author)
The above table effectively shows the computation of expected returns and risks which is
associated with the stocks of MYOB ltd and another Hypothetical company which is considered
for the purpose of making effective comparisons. The above figure effectively shows the
computation and presentation of Security market line, Portfolio beta and Portfolio return
(Mehrara, Falahati and Zahiri 2014). The presentation can help in detecting whether the portfolio
which is created is appropriate and whether the same is consistent with the CAPM formula. The
security market line is a graphical representation of the Capital Asset Pricing Model which can
represent different level of systematic risks or market risks for different securities (Rizwan,
Shaikh and Shehzadi 2013). The portfolio returns and risks are clearly depicted on the Security
market line which is a clear sign that appropriate formula is used for estimating and depicting the
returns which is associated with the investment. As per the computation which is shown in the
table above, the estimated portfolio return is shown to be 2.26 while at the same time the beta

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associated with the portfolio is shown to be 0.08. The combination of risk and return is
appropriately presented in the Security market line and the same is shown due to equal portfolio
weights.
Conclusion
The above discussion effectively shows that an investment is associated with different
types of risks and any investment decisions are generally taken after considering the risks and
returns which are associated with the investment. In order to effectively manage the risks a
portfolio which contain different variety of stocks is created. It is to be noted that a portfolio
forms an important component for investment and also an important tool for investors for
minimizing the risks attributable to the investment. In addition to this, the investors also have an
option to minimize the risks by adopting diversification method which spreads the risks of the
portfolio. The above discussion shows that appropriate formulas are applied such as CAPM for
deriving the portfolio returns and also shows the security market line for the portfolio.

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Reference
Acheampong, P. and Agalega, E., 2013. Does the capital assets pricing model (CAPM) predicts
stock market returns in Ghana? Evidence from selected stocks on the Ghana Stock
Exchange. Research Journal of Finance and Accounting, 4(9).
Ahuja, A., 2015. Portfolio Diversification in the Karachi Stock Exchange. Pakistan Journal of
Engineering, Technology & Science, 1(1).
Anjum, S., 2014. Systematic Risk Outliers and Beta Reliability in Emerging Economies:
Estimation-Risk Reduction with AZAM Regression. Review of Integrative Business and
Economics Research, 3(1), p.269.
Bromiley, P., McShane, M., Nair, A. and Rustambekov, E., 2015. Enterprise risk management:
Review, critique, and research directions. Long range planning, 48(4), pp.265-276.
Darolles, S., Gouriéroux, C. and Jay, E., 2015. Robust portfolio allocation with systematic risk
contribution restrictions. In Risk-Based and Factor Investing (pp. 123-146). Elsevier.
Džaja, J. and Aljinović, Z., 2013. Testing CAPM model on the emerging markets of the Central
and Southeastern Europe. Croatian Operational Research Review, 4(1), pp.164-175.
Francis, J.C. and Kim, D., 2013. Modern portfolio theory: Foundations, analysis, and new
developments (Vol. 795). John Wiley & Sons.
Mehrara, M., Falahati, Z. and Zahiri, N.H., 2014. The Relationship between systematic risk and
stock returns in Tehran Stock Exchange using the capital asset pricing model
(CAPM). International Letters of Social and Humanistic Sciences (ILSHS), 10, pp.26-35.

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Rizwan, S., Shaikh, S.J. and Shehzadi, M., 2013. Validity of capital assets pricing model
(CAPM): evidence from cement sector of Pakistan listed under Karachi stock exchange. Kuwait
Chapter of Arabian Journal of Business and Management Review, 33(855), pp.1-16.
Zabarankin, M., Pavlikov, K. and Uryasev, S., 2014. Capital asset pricing model (CAPM) with
drawdown measure. European Journal of Operational Research, 234(2), pp.508-517.