What Investment Entails Concerning Future Share Period Returns Finance Essay

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Investment entails some degree of uncertainty concerning future share period returns. In financial perspective risk is a synonym for uncertainty while return signify the totality of gain or loss on an investment. Risk in investment cannot be eliminated but can be managed through number of strategies such as diversification, asset allocation etc. This study was conducted to help Sandra (widow) manage her inherited portfolio by explaining to her on how reduce the risk level of her portfolio and risk-return tradeoffs. RELATIONSHIP BETWEEN RISK AND RETURN Risk is the possibility of suffering a financial loss due to vagueness in terms of Macroeconomic fluctuations, asset-specific unexpected developments, and changing fortunes of various industries (Bodie et.al 2007). While return is the overall gain or loss on an asset. Risk and return cannot be separated from one another in an investment as the required return depends on the risk of the investment (Stephen A. Ross et.al 2008). Companies Utility Company High-Tech Company Counter Cyclical Company Return 9.70% 10.0% 5.0% Risk 2.65% 21.91% 12.07% In the table above, it is clearly illustrated that High-Tech Company has higher risk and return compared to Utility Company and Counter Cyclical Company while Counter Cyclical Company has higher risk and return compared to Utility Company. That is, the greater the risk, the greater the return and vice versa as clearly depicted in appendix A. BETA AND ITS RELEVANCE TO REQUIRED RETURN ON STOCKS In view of the fact that risk are related to return in an investment and that some risk (Unsystematic) can be eliminated by diversification, therefore such risk cannot be rewarded since it s borne unnecessarily. The expected return on an investment depends only on that stock systematic risk. Beta assesses how volatile an asset is in relation to the general market (Elton and Gruber, 1991) i.e. it assess a risk that arises from the relationship between the return on an asset and the return on the market. It also measures the systematic risk and doesn t change no matter the economic situation. In appendix B the composite index was chosen to calculate for beta instead of index fund because it is associated with a higher expected return of 18.7% and less risk of 4.96% compared to Index fund which has an expected return of 8.40% and risk of 10.72% as illustrated in appendix A. The higher the required return and expected return the Higher the beta (risk). Stock Beta Required Return Expected Return Utility Company 0.529 12.24% 9.70% High T Company 4.043 60.39% 10.00% C.C Company -2.109 -23.89% 5.09% Diversification and Its Importance to Investment The simple fact that an asset is associated with diverse degrees of expected risk leads most investors to the notion of holding more than one security at a time. According to Fischer and Jordan ((1999)), endeavour to reduce and spread risk take the form of diversification. Diversifying investment means spreading risk across variety of asset classes i.e. investment. Investors invest their money in firms of dissimilar industries to avoid the risk of losing their portfolio because no matter the situation of the economy,

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