Risk assessment analysis

Solution Preview

I need to know how to work the problem
HOW TO WORK THE PROBLEM IS GIVEN SEPARATELY AS AN ATTACHMENT.
I need enough info to write a page

The use of Beta to Strident Marks is limited.
Beta (market sensitivity) is a measure of the extent to which your fund's portfolio fluctuates with the market as represented by the S&P 500. To calculate beta, you measure the sensitivity of your fund's portfolio to market patterns. Beta is a statistical estimate of the average change in your fund's rate of return corresponding to a 1% change in the market. Uncertainty associated with future investment returns achieved over time and historically is related to the variability of returns. The risk characteristics of any investment are also generally related to the investment's expected return.
Beta can help Strident Marks
Beta is a measure of a stock's volatility in relation to the market. By definition, the market has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the market. A stock that swings more than the market over time has a beta above 1.0. If a stock moves less than the market, the stock's beta is less than 1.0. High-beta stocks are supposed to be riskier but provide a potential for higher returns; low-beta stocks pose less risk but also lower returns.

Beta is a key component for the 'capital asset pricing model' (CAPM), which is used to calculate cost of equity. Recall that the cost of capital represents the discount rate used to arrive at the present value of a company's future cash flows. All things being equal, the higher a company's beta is, the higher its cost of capital discount rate. The higher the discount rate, the lower the present value placed on the company's future cash flows. In short, beta can impact a company's share valuation.

Advantages of Beta to Strident Marks
To followers of CAPM, beta is a useful measure. A stock's price variability is important to consider when assessing risk. Indeed, if you think about risk as the possibility of a stock losing its value, beta has appeal as a proxy for risk.

Intuitively, it makes plenty of sense. Think of an early-stage technology stock with a price that bounces up and down more than the market. It's hard not to think that stock will be riskier than, say, a safe-haven utility industry stock with a low beta.

Besides, beta offers a clear, quantifiable measure, which makes it easy to work with. Sure, there are variations on beta depending on things such as the market index used and the time period measured, but broadly speaking, the notion of beta is fairly straightforward to understand. It's a convenient measure that can be used to calculate the costs of equity used in a valuation method that discounts cash flows.

Disadvantages of using Beta to Strident Marks
However, if you are investing in a stock's fundamentals, beta has plenty of shortcomings.

For starters, beta doesn't incorporate new information. Consider the electrical utility company American Electric Power (AEP). Historically, AEP has been considered a defensive stock with a low beta. But when it entered the merchant energy business and assumed high debt levels, AEP's historic beta no longer captured the substantial risks the company took on. At the same time, many technology stocks, are so new to the market they have insufficient price history to establish a reliable beta.

Another troubling factor is that past price movements are very poor predictors of the future. Betas are merely rear-view mirrors, reflecting very little of what lies ahead.

Furthermore, the beta measure on a single stock tends to flip around over time, which makes it unreliable. Granted, for traders looking to buy and sell stocks within short time periods, beta is a fairly good risk metric. But for investors with long-term horizons, it's less useful.

Re-Assessing Risk for Strident Marks
The well-worn definition of risk is the possibility of suffering a loss. Of course, when investors consider risk, they are thinking about the chance that the stock they buy will decrease in value. The trouble is that beta, as a proxy for risk, doesn't distinguish between upside and downside price movements. For most investors, downside movements are risk while upside ones mean opportunity. Beta doesn't help investors tell the difference. For most investors, that doesn't make much sense.

CALCULATION OF EXPECTED RETURN USING BETA
Please do this for Strident Marks
Let us assume that:
· the return on "risk-free investments (i.e. Beta = 0)is 6% per annum
· the return on securities carrying "Market Risk" (i.e. Beta = 1) is 10% per annum
then the premium for a Beta of 1 is 4% per annum.
A security with a Beta value of 0.7 would, theoretically, offer a return of:
6% + (0.7 x 4%) per annum
i.e. 6% + 2.8% per annum
i.e. 8.8% per annum
A security with a Beta value of 2.5 would, theoretically, offer a return of:
6% + (2.5 x 4%) per annum
i.e. 6% + 10% per annum
i.e. 16% per annum
RELATIONSHIP OF EXPECTED RETURN TO MARKET PRICE
There will, in theory, be a direct relationship between expected return and market price - essentially, expected return, market price and Beta value are all interlinked.
The higher the Beta (and, thus, the expected return), the lower will be the market price of the security.
The lower the Beta (and, thus, the expected return), the higher will be the market price of the security. How do you assess the beta of Strident Marks?

Risk assessment should be undertaken at both the individual security and portfolio level. Those who may ...