Risk Management Models and Investment Analysis Assignment

This assignment delves into risk management models and their application in financial analysis. It begins by emphasizing the importance of considering both risk and returns when evaluating financial assets, highlighting the use of historical data, future scenario projections, and probability assignments to determine mean returns and associated risks. The assignment discusses risk management techniques such as Value at Risk (VAR) and portfolio diversification to mitigate potential losses. It stresses the significance of continuous quantitative analysis and the consideration of qualitative factors in investment decisions. The practical section of the assignment analyzes the weekly returns of ASX 200 and allocated stocks using provided formulas and descriptive statistics, including the calculation of weekly returns, coefficient of variation, cumulative wealth index, and geometric mean. The analysis reveals volatility trends and presents a risk-return plot, allowing for a comparative assessment of investment options, ultimately ranking the stocks based on their risk-return profiles, with ASX200 being the preferred choice and BHP the least desirable.

RISK
MANAGEMENT
MODELS
STUDENT ID:
[Pick the date]

TASK 1
For evaluation of any given financial asset class, two aspects need to be considered
simultaneously i.e. associated risk and returns. It is imprudent to expect that an investment
decision could be made by analysing only one of the above aspects. From an investor
perspective, the primary step for making investment decisions is to compute the associated
returns and risk based on the historical or empirical data available. Also, it is noteworthy that
historical returns may not be a good or reliable estimator of the future performance of the
underlying asset or project. Hence, it is required to identify the key risk elements going
forward which can impact the associated return with the asset under consideration (Parrino
and Kidwell, 2011).
Then using the modelling techniques, the potential future scenarios need to be estimated and
the underlying returns in these different scenarios need to be projected. Further, numerical
probabilities need to be assigned to various scenarios so that a mean return could be
determined on the asset. Based on the past and expected future variation in returns, the risk
associated with the underlying asset is determined. Also, it is noteworthy that risk
management techniques would also be need to put in place so as to ensure that the downside
is capped and the overall risk is reduced. This can be done through terminologies such as
VAR or value at risk (Petty et. al., 2015). Risk hedging can be carried out with techniques
such as diversification of portfolio. In diversification, the investor tends to invest in assets
such that there is a natural hedge. As a result, if one basket of asset is underperforming then
this could be compensated by the relative outperformance of the other asset class. Also, with
regards to investing, it is critical that quantitative analysis is not limited to just measuring risk
and returns at the time of making business decisions but as and when there is any significant
change, various models need to be run so as to estimate the change in intrinsic value of the
asset. Based on this, suitable and timely exit should be planned (Northington, 2011).
The use of descriptive statistics in making business and investment decisions ensures that the
decisions are objective and have firm basis which can be used to justify the investment
rationale if the need arises. Without adequate data analysis, there is a potential fear that the
business or investment decision may be driven by intuition or other biases which may result
in irrational decision making leading to losses. However, while statistical analysis with
regards to risk and return is pivotal, it is imperative that qualitative factors must also be
considered (Brealey, Myers and Allen, 2012).

Task 2
a) The weekly returns of ASX 200 along with the allocated stocks have been computed in the
excel sheet attached. The relevant formula that has been used is listed below (Petty et. al.,
2015).
Weekly Returns (%) = [(Pt/Pt-1) -1]*100
b) The requisite plot for returns is as indicated below.
It is apparent from the above figure that volatility of weekly returns is quite low from
December 2016 to the present (i.e. February 2018). This is apparent from the value of weekly
returns which have been capped within a small range of -1% to 2%. This is unlike the period
from June 2014 to November 2016 which has been quite volatile with wild swings in excess
of 4% on weekly basis on either side. A period of low to moderate volatility has been
witnessed for the period leading to March 2014.
c) The requisite descriptive statistics related to returns are listed below.

Formula used:
1) Coefficient of Variation = Standard Deviation/Mean
2) Cumulative Wealth index = (Ending value/Starting Value)*100
3) Geometric mean = (R1*R2*…….Rn)1/n
4) Probability of negative returns = Number of negative weekly returns/Total
observations
d) The requisite risk returns plot is as indicated below.

It is apparent from the above risk return plot that index (ASX 200) offers the lowest risk and
one of the highest returns making it the best choice amongst the available options. BHP stock
is the worst choice owing to the highest risk and the lowest returns (that too negative). From
an investor perspective, higher returns and lower risk would be preferable (Northington,
2011). Thus, in order of decreasing preference, the following sequence is obtained.
ASX200>CBA>NAB>ANZ>WEST>BHP

References
Brealey, R.A., Myers, S.C. and Allen, F. (2012) Principles of corporate finance. 2nd edn.
New York: McGraw-Hill Inc.,US.
Northington, S. (2011) Finance, 4th ed. New York: Ferguson
Parrino, R. and Kidwell, D. (2011) Fundamentals of Corporate Finance, 3rd ed. London:
Wiley Publications
Petty, JW, Titman, S, Keown, AJ, Martin, P, Martin JD and Burrow, M. (2015), Financial
Management: Principles and Applications, 6th ed. Sydney: Pearson Australia,