Essays on Risk and Return Coursework

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The paper "Risk and Return" is a perfect example of a finance and accounting coursework.   Risk is the probability that the actual return from an investment might be different from the expected. Just as life is composed of numerous uncertainties, investing just like driving or taking a walk down the street is an exposure of oneself to risk. The amount of risk one can accommodate (also known as risk appetite), is largely dependent on one's personality and lifestyle. Investors are either risk lovers or risk-averse. Investors are risk-averse if they avoid risky opportunities and only allow a minimal level of risk in their portfolio.

On the contrary, risk lovers, for instance, day traders embrace a lot of risks and often feel inadequate if they are not making dozen of trades in a day (Campbell & Vicera, 2002). Thus, investing in any instrument such as bonds, stocks or shares exposes an investor to different types of risks. In order to maximize the returns, prudent investors should be aware of the types of risks they are exposed to, estimate the amount of risk, and identify methods of mitigating the risks. Return, risk and the Security market line The expected return of an investment is calculated as the weighted average of the likely profits of the individual assets in the portfolio, weighted by the possible profits of each of the asset class.

The formula is Also represented as E(R) = w1R1  + w2Rq  + . ..+ wnRn In the first example, the expected return for a portfolio of two mutual funds; one invested bonds and the other in stocks. The expected return from the stock is 12% and the return from the bond is 6% while the allocation to each asset class is 50%; Expected return E(R) = (0.12)*(0.5) + (0.06)*(0.5) = 0.09 or 9% Although the expected return is not always a guaranteed rate of return for an investment, it can, however, be used to forecast the future value of a portfolio.

Investors also use expected return as a guide to estimate actual returns. In Example 2, another portfolio of stocks A and B; with stock A having an expected return of 20% and weight of 30% in the portfolio and stock B has expected return of 70% and weight of 30%.

References

1. Bodie, Z., Kane, A. & Marcus, A. J. (2008). Investments (7th International ed.). McGraw-Hill: Boston.

2. Campbell, J & Vicera, M. (2002). "Strategic Asset Allocation: Portfolio Choice for Long Term Investors". Clarendon Lectures in Economics. Oxford University Press: London.

3. Connor,G., Goldberg, L. R., Korajczyk, R. A. (2010). Portfolio Risk Analysis. Princeton University Press: New York.

4. Luenberger, D. (1997). Investment Science. Oxford University Press: London.

5. Rubinstein, M. (2006). A History of the Theory of Investments. John Wiley & Sons, Inc: Hoboken

6. Zhong, M. (2007). Estimation of Portfolio Value-at-Risk and Expected Shortfall Using Copulas, Extreme Value Theory, and Doubly Noncentral T Distribution. State University of ProQuest: New York at Albany.

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