Overview
Assessment 7
Respond to three questions and solve three computational problems about the risk-and-return relationship.
Every investment carries a different level of risk and return. It is useful to explore different measures of risk and learn how to compare risk with the return, as well as differentiate between standalone risk and portfolio, or market, risk.
By successfully completing this assessment, you will demonstrate your proficiency in the following course competencies and assessment criteria:
• Competency 2: Define finance terminology and its application within the business environment.
o Explain what the coefficient of variation measures.
o Calculate the dollar return on an investment.
o Calculate the percentage of return on an investment.
o Calculate the coefficient of variation of stocks.
o Explain how risk is measured.
• Competency 3: Evaluate the financial health of an organization.
o Identify the total level of risk of a stock.
o Define the concept of risk.
o Identify a source of firm-specific risk.
Assessment Instructions-
Respond to the questions and complete the problems.
Questions
In a Word document, respond to the following. Number your responses 1–3.
1. Define risk, and explain how it is measured.
2. Identify a source of firm-specific risk. What is the source of market risk?
3. Explain what the coefficient of variation measures.
Use references to support your responses as needed. Be sure to cite all references using correct APA style. Your responses should be free of grammar and spelling errors, demonstrating strong written communication skills.
Problems
In either a Word document or Excel spreadsheet, complete the following problems.
• You may solve the problems algebraically, or you may use a financial calculator or an Excel spreadsheet.
• If you choose to solve the problems algebraically, be sure to show your computations.
• If you use a financial calculator, show your input values.
• If you use an Excel spreadsheet, show your input values and formulas.
In addition to your solution to each computational problem, you must show the supporting work leading to your solution to receive credit for your answer.
1. Two years ago, Conglomco stock ended at $73.02 per share. Last year, the stock paid a $0.34 per share dividend. Conglomco stock ended last year at $77.24. If you owned 200 shares of Conglomco stock, what were your dollar return and percent return last year?
2. Calculate the coefficient of variation for the following three stocks. Then rank them by their level of total risk, from highest to lowest:
o Conglomco has an average return of 11 percent and standard deviation of 24 percent.
o Supercorp has an average return of 16 percent and standard deviation of 37 percent.
o Megaorg has an average return of 10 percent and standard deviation of 29 percent.
3. Year-to-date, Conglomco has earned a −1.64 percent return, Supercorp has earned a 5.69 percent return, and Megaorg has earned a 0.23 percent return. If your portfolio is made up of 40 percent Conglomco stock, 30 percent Supercorp stock, and 30 percent Megaorg stock, what is your portfolio return?
Suggested Resources-
The following optional resources are provided to support you in completing the assessment or to provide a helpful context.
Library Resources:
• Weaver, S. C., & Weston, J. F. (2001). Finance and accounting for nonfinancial managers. New York, NY: McGraw-Hill.
• Sherman, E. H. (2011). Finance and accounting for nonfinancial managers (3rd ed.). New York, NY: American Management Association.
Course Library Guide
You are encouraged to refer to the resources in the BUS-FP3062 – Fundamentals of Finance Library Guide to help direct your research.
Other Resources
• Cornett, M., Adair, T., & Nofsinger, J. (2019). M: Finance (4th ed.). New York, NY: McGraw-Hill. Available in the courseroom via the VitalSource Bookshelf link.
Characterizing Risk And Return
1.
A risk is a probability of a project’s or investment’s outcome varying from the expected outcome or gains in a financial context. Scholars aver that there are two types of risk in investment: systematic and unsystematic risk (Raza et al., 2014). Systematic risk affects the whole market; implying that all investors are likely to incur losses arising from this type of risk. Conversely, unsystematic risk affects a particular company or investment portfolio. Often, investors measure risk using five principles: alpha, beta, R-squared, standard deviation, and Sharpe ratio. The alpha measures risk relative to a market benchmark index. For example, if the DJIA is the benchmark index, investment risk is measured against this index. Beta measures systematic risk by comparing an investment against a benchmark index. For example, if the beta is below one, it is considered less volatile than the benchmark index.
On the other hand, the R-squared measures the degree of movement of an investment relative to a benchmark index. For example, if an investment has an r-squared value of 50, it is said to have a low correlation to the benchmark index. The standard deviation measures risk by assessing the data dispersion relative to the mean value. The end value of this dispersion determines the volatility of an investment. Lastly, the Sharpe ratio measures risk by assessing an investment performance relative to the adjusted associated risks. For example, if one investor generates a 15% return and another a 10% return, the first investor is said to perform better than the latter.
As noted, risk can either be attributed to a market or a specific firm. Bradfield (2007) describes a firm-specific risk as the unpredictable variability in earnings of a particular company that is only specific to that firm rather than systematic macroeconomic events. Simply put, a firm-specific risk is a risk that only affects the gains or outcomes in one particular company. Conversely, some scholars describe a market risk as a risk that affects a property’s position in the economic cycle (Wieland, 2020). A market risk on an investment’s outcomes arises from changes in market prices. Market risks may stem from multiple sources, including economic recessions, changes in interest rates which make investments less profitable, natural disasters that affect a country’s economic and political turmoil. As seen from this list, market risks are often beyond a firm’s control, and they tend to affect all market participants.
A coefficient of variation is a technique used by investors to assess an investment’s riskiness and determine whether its return is worth its volatility over time. Typically, a lower coefficient of variation suggests a favourable risk worth the volatility while a high ratio shows an unfavourable tradeoff between the two variables.
References
Bradfield, J. (2007). Introduction to the economics of financial markets. Oxford University.
Raza, S.A., Jawaid, S.T., & Hussain, A. (2014). Risk and investment decisions in stock markets: Evidence from four Asian countries. International Journal of Managerial and Financial Accounting, 6(3), 227-250. https://www.researchgate.net/deref/http%3A%2F%2Fdx.doi.org%2F10.1504%2FIJMFA.2014.065240
Wieland, D. (2020, August 5). Assessing three types of risk in real estate. Forbes. https://www.forbes.com/sites/forbesrealestatecouncil/2020/08/05/assessing-three-types-of-risk-in-real-estate/?sh=820f1246a30a
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