Components of a Stock’s Realized Return, Essay Example

It confirmed that stock’s realized return has to deal with distributions, dividends and appreciation of share price. All dividends are directly used and reinvested to buy additional shares of the same security or stock. The realized returns distribution is standard deviation, which is the square root of the variance of the distribution that measures the change in return by calculating the returns’ difference between the returns and the average return and squaring those differences. Realized returns are considered the total return that appears at particular time period. The realized returns’ components are realized return and portfolio of Individual investment. The first one has to do with the portfolio stability itself. If the return rate for the portfolio in general is less or should decrease, this is a symbol that some diversification in the investments types would be a good impression. When computing the realized return in relation to the portfolio that involves bond issues, it is vital to demonstrate on the real interest payments that have been received on a bond coupon for the period analyzed.

Contrast systematic and unsystematic risk.

Systematic risk, in fiancé, also called aggregate risk, market risk, or un-diversifiable risk, is a risk that is associated with aggregate returns of market. Unsystematic risk, in contrast, also called idiosyncratic risk, specific risk, residual risk, or the diversifiable risk, is the industry specific or company-specific risk within a portfolio, which is not associated with aggregate returns of market. The risk which is unsystematic can be eliminated or minimized by diversification, and systematic risk cannot be diversified. Unsystematic risk must not be mixed up with systemic risk, the risk of loss from few disastrous events that crumple the complete financial system. Take the example of an individual investor who buys $10,000 of stock in 10 corporations. If unexpected events result into a disastrous setback and one or two corporations’ stock prices fall down, the investor faces a loss. On the other hand, if an investor who buys $100,000 in a single corporation would result into ten-time  losses from such a disastrous event. The portfolio of second investor involves more risk of unsystematic nature than the diversified portfolio. Lastly, if the setback were to influence the whole industry in its place, the all investors would face similar losses, because of the systematic risk.

Explain why the total risk of a portfolio is not simply equal to the weighted average of the risks of the securities in the portfolio.

Modern portfolio theory is an investment theory which seeks to maximize the expected return of portfolio for a stated amount of portfolio risk, or similarly reduce the risk for a given amount of expected return, by gently selecting the various assets’ proportions. Although the theory of Modern portfolio is broadly used in the financial industry practices, and many of its creators received a Nobel memorial prize for the theory, in current years the general beliefs of this theory have been extensively criticized by behavioral economics fields.

Modern portfolio concept is a mathematical computation of the diversification concept in investing, with the objective of choosing portfolio of investment assets that have lower risk collectively than any single asset. This is possible and can be seen instinctively since various assets types often vary in value in contrary ways. For instance, as stock market prices tend to shift separately from the prices in the bond market, a group of both kinds of assets can thus have less risk overall than either individually. But diversification reduces the risk even if returns from assets are not negatively connected certainly, even if they are correlated positively.

State what beta measures and its uses.

Interest portfolio in the formulation of CAPM is the portfolio of market that involves all risky assets, and so the rp terms in the above discussed formula are replaced by rm, the rate of return of the market.  Beta is also considered as financial elasticity or relative volatility that is correlated, and can be considered to as a sensitivity measure of the returns of an asset to returns of market, its un-diversifiable risk, and its systematic risk. On a single asset level, the beta calculation can provide hints to liquidity and volatility in the marketplace. In the management of fund, beta calculation is considered to separate a skill of a manager from her or his consent to take a risk.

State what WACC measures and explain the WACC assumptions used to value a project.

A computation of the firm’s cost of capital in which every category of capital is weighted proportionately. All capital sources – preferred stock, common stock, bonds and any other type of long-term debt are counted the calculation of WACC. All else equal, the firm’s WACC increases as the rate of return and beta and on equity increases, as an increase in WACC observes a reduction in valuation and a greater risk.