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Create a 7 page essay paper that discusses Finance risk in a portfolio context.Download file to see previous pages... for an investor to do his assignment carefully to determine the magnitude of risk
Create a 7 page essay paper that discusses Finance risk in a portfolio context.
Download file to see previous pages...for an investor to do his assignment carefully to determine the magnitude of risk associated with the investment so as to make a good decision to avoid huge losses. The main aim of an investor is to try and reduce the chances of risk as much as possible. It is a general rule that the when the chances of risk are high, the rate of return is usually high. However, there are some exceptions to this rule. Different projects have different levels of risk and hence different rates of return. Therefore, in order to correctly assess the risk one should consider portfolio (Chandra, 2011). Portfolio Theory The theory is also referred to as the modern portfolio theory and was developed and introduced by Harry Markowitz in the year 1952. Under this theory, it is assumed that the returns from an investment activity are spread over the period of time being analysed. The objective of this theory is to maximize the expected return of a portfolio for a certain level of portfolio risk. In other words, it attempts to minimize the level of risk associated with a certain level of expected return. They concept that guides this theory is that when calculating the risk level, an investment should not be considered alone. It is important for the investor to evaluate several investments varies in prices in comparison with other investments in the portfolio varies in prices (Brealey, Myers &. Allen, 2011). When making an investment, one trade- off between a risk and a return and therefore the investor should always try to choose the investment that will give him the highest returns possible. The C.A.P.M In order to determine the theoretical rate of return that is appropriate for an investment, Capital Asset Pricing Model (CAPM) is used (Brealey, Myers &. Allen, 2011). Assets that are evaluated...
In order to determine the theoretical rate of return that is appropriate for an investment, Capital Asset Pricing Model (CAPM) is used (Brealey, Myers &. Allen, 2011). Assets that are evaluated using this model can be included in an existing diversified portfolio if their non- diversifiable risk is known. In doing the calculation, the sensitivity of the investment to systematic risk is taken into consideration. This risk is represented by the symbol β. The projected market return and the projected theoretical return of the risk free investment are also determined. . The formula for CAPM used to determine the expected rate of return is as follows. .The measure of systematic risk used in CAPM is important since the investors can compare it with that of other investments in the market. They can therefore go ahead and select the best investment. In addition, they are able to improve their portfolio and reduce the chances of risk. Managers can also use the model to determine the required rate of returns for investment (Chandra, 2008).Long Term FinancingIn a business, there are those investments whose returns are expected for a long period of time usually over one year. These are usually investments in long term assets such as machinery and buildings. The money needed to finance these investments should be available for a long time (Brealey, Myers &. Allen, 2011). The time required to pay back the finance should exceed one year. A company should have a good mix of long term financing (capital structure). . This will help reduce the cost of capital as well as the risk involved. The investor should have a good business plan so as to make a good investment portfolio that reduces risks. The company will get a long term debt depending on the collateral available. The manager should be able to select between the short term and the long term financing. To do this, they should consider the risk-return trade off. It is important to note that long time financing is less risky as compared to the short term financing.
