Southern Cross University Finance: Risk Analysis Case Study Report

This report presents a comprehensive risk analysis of Cochlear Ltd, evaluating its financial risk using the Capital Asset Pricing Model (CAPM) and beta coefficients. It calculates the required rate of return and explores portfolio measures, comparing the company's risk profile with a hypothetical company. The analysis delves into risk and return estimates, examining the relevance of beta in risk assessment and comparing the financial and business risks of the company. The report utilizes historical data and financial models to determine the risk and return profile of the company, offering insights into investment decisions and portfolio diversification. The findings highlight the importance of understanding risk and return relationships for informed financial decision-making.

0Running head: FINANCE
SOUTHERN CROSS UNIVERSITY
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Part B: Risk Analysis
Introduction
Risk Assessment of a company can be well defined in terms of investment. Every
financial asset investment is associated with some or the other form of risk it can be either
financial risk or business risk. Beta is an important factor in terms of the risk associated with an
investment. The beta of the stock shows the sensitivity of a stock with respond to a stock and the
same is accounted for assessing the movement of the stock with respect to a benchmark index.
The beta of the Cochlear Ltd Company was assessed thereby analyzing the financial risk
associated with the project (Fabrizio 2017).
Discussion
Risk and Return Estimates
Required Rate of Return
The risk and return estimates was done for determining the required rate of return for the
stock via the Capital Asset Pricing Model and the same can be well estimated by taking the key
factors like the prevailing risk free rate in the economy, the return generated by the market index
and the beta of the stock. The risk free rate for the stock was taken at 1.95%, the return generated
on the market index was taken at 3.29% and the beta of the stock was derived by regressing the
returns of the stock over the benchmark index. The required rate of return was evaluated to be
around 3.27% for the stock and the same was much closer to the return generated by the market
index due to the positively correlated beta of the stock. On, the other hand side, negative beta

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taken for the hypothetical company at -0.2 times generated a return of around 1.68% reflecting
the required rate of return by the investors for the return generated by this stock.
Cochlear Ltd Hypothetical Company
Capital Asset Pricing Model Capital Asset Pricing Model
Beta
0.986157
6 Beta -0.2
Risk Free Rate 1.95% Risk Free Rate
1.95
%
Return on Market 3.29% Return on Market
3.29
%
Required Rate of
Return 3.27% Required Rate of Return
1.68
%
Portfolio Measures
It is essential to enjoy the benefit of diversification and that can be well managed by
investors with the help of building an efficient portfolio giving appropriate weights to stocks.
Each of the constituent the COC Ltd stock and the hypothetical stock were given a weightage of
around 50% equally. On a combined portfolio basis the required rate of return would be around
2.47% and the combined beta of the portfolio would be around 0.39 times.
Portfolio Weights
Cochlear 50%
Hypothetical 50%
Portfolio
Returns
(%)
Cochlear 1.63%
Hypothetical 0.84%
Total 2.47%
Particulars Beta
Portfolio
0.393078
8

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Risk and Return Analysis
Required Rate of Return
The required rate of return shows the return required by the shareholders of a company
for a particular amount of risk taken by the investors of the company. The return analysis for the
Cochlea Ltd Company was done by taking the five-year data, historical share price of the
company (Suyanto and Sibarani 2018). The beta of the Cochlea Stock was around 0.98 times and
on the other hand, side the beta of the Hypothetical Company was taken at -0.20 times. A beta of
0.98 times for the Cochlea Company shows that the performance of the stock is somewhat
related to the performance of the Benchmark Index. On the other hand, side, the beta of -0.20
times shows that the return of the stock is comparatively contrary. Reflecting that if the market
moves (increases) by around 1% then the return of the stock would possibly move down by -0.20
times. The required rate of return is an important factor that needs to be considered while
evaluating the return of stock thereby including the risk free rate in the economy, the beta of the
stock and the simultaneous return generated by the stock. The required rate of return for both the
stocks were generated by the following formula:
Capital Asset Pricing Model (Re) = Risk Free Rate of Return + (Beta*(Return on Market-Risk
Free Rate of Return)).
Cochlear Ltd Hypothetical Company
Capital Asset Pricing Model Capital Asset Pricing Model
Beta
0.9861575
8 Beta -0.2
Risk Free Rate of Return 1.95% Risk Free Rate of Return 1.95%
Return on Market 3.29% Return on Market 3.29%
CAPM (Re) 3.27% CAPM (Re)
1.68
%

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Risk and Return Theory
The concept of risk and return can be well regarded in terms of the risk taken by the
investor while investing in a financial security. The return generated by the stock and the return
required by the shareholders of the company are some of the important factors that needs to be
accounted. The required rate of return generated via the CAPM Model for the Cochlear Ltd was
around 3.275 while the return generated by the company was around 26.53% (Jahan and Ahmed
2017). The higher return generated by the company in these five-years of time could be well
attributed to the rising profits and the operational activities of the company. It is important to
determine the risk and return analysis of the company and the same could be well calculated with
the help of the return generated by the stock and the simultaneous risks taken by the company
(Kenfack et al. 2016).
Meaning and relevance of Beta in Risk Analysis
Beta of a stock shows the sensitivity of stock with respect to the changes in the value of
the stock from the movement of the benchmark index. Beta also reflects the riskiness of the stock
when compared to the benchmark index in the terms of volatility of the stock. The beta for the
Cochlear Ltd Company was around 0.98 times that shows that if the stock moves by around 1%
then the stock is expected to change by about 0.98% (Patel and Verma 2018). The beta of the
Hypothetical Company on the other hand was -0.20 times this shows that for every 1% increase
in the market index the stock is expected to fall by about -0.20% (Cervelló-Royo, Guijarro and
Michniuk 2015).
Risk Comparison
The debt to equity percentage for the company was around 25% implying the financial
risk for the company was comparatively less for the company; Business risk and financial risk

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are the two main types of risk that should be accounted while analyzing the financial position of
the company. The financial risk for the company has been moderate and on the other hand, the
business risk for the company has somewhat been stable for the company. The beta of the
company was also comparatively less for the company around 0.98 times implying lessor volatile
movement of the stock (Chaibi, Alioui and Xiao 2015).
The risk of the Cochlear Ltd Company was comparatively less for the company when
compared to the Hypothetical Company. The risk return for the Cochlear Ltd Company was
comparatively better for the company. The risk and return analysis could be well estimated with
the help of this showing the risk return benefit earned by an investor.
Conclusion
The risk return analysis of the company can be well compared with the help of the data
collected for the company for the past five-year where several risk and return analysis were done
for the company. The application of the CAPM model was done for determining the required rate
of return for the companies and the respective beta of the company. The required return
generated from the Cochlear Ltd Company was much more consistent than the Hypothetical
Company.

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References
Fabrizio, D.S., 2017. Is the CAPM valid? An Empirical Analysis in USA Stock Exchange.
Kenfack, H., Dubois, P., David, K., Patrick, B.M.H. and Olufemi, A.P., 2016. The pricing of
illiquidity risk on emerging stock exchange markets: A portfolio panel data analysis. Journal of
Economics and International Finance, 8(8), pp.127-141.
Patel, R.A. and Verma, B., 2018. The Effect of Risk Return Analysis of Pharmaceutical
Companies on Indian Stock Market. International Journal of Engineering and Management
Research (IJEMR), 8(6), pp.130-134.
Cervelló-Royo, R., Guijarro, F. and Michniuk, K., 2015. Stock market trading rule based on
pattern recognition and technical analysis: Forecasting the DJIA index with intraday data. Expert
systems with Applications, 42(14), pp.5963-597
Chaibi, A., Alioui, S. and Xiao, B., 2015. On the impact of firm size on risk and return: Fresh
evidence from the American stock market over the recent years. Journal of Applied Business
Research, 31(1), p.29.
Jahan, S. and Ahmed, R., 2017, September. Risk and Return Relationship: Analysis on a
Selected Industry of Dhaka Stock Exchange. In Welcome Message from Conference Chairs (p.
21).
Suyanto, M. and Sibarani, F.N.H., 2018, March. Stock investment analysis, idiosyncratic risk
and abnormal return. In 15th International Symposium on Management (INSYMA 2018). Atlantis
Press.