Case Study on Risk and Return

Topics: Capital asset pricing model, Modern portfolio theory, Investment Pages: 9 (3065 words) Published: April 7, 2013
Powerline Network Corporation—Case Two: Risk and Return
Thomas Calderone, CJ Anderson, and Megan Wegener
FIN 480: Finance Capstone Course
Professor Randy Lewis
Spring Arbor University
February 7, 2013

Powerline Network Corporation: Risk and Return
The topics of risk and return are crucial to financial management because it allows a company to maximize stock value—in which risk is a determinant value, the rate of return in which investors require on various types of securities depends on their individual risks; and common and preferred stocks, bonds, and mutual funds are use for multiple things—401 K plans, for example— and each incur a certain amount of risk that are inherent to the type of investment. It is also important to note that creating optimal portfolios vary from investor to investor and depend greatly on age, risk tolerance, and other characteristics unique to investors. The issues discussed in this case all refer back to these fundamentals of risk and return and dig in deep to what the PNC directors need to learn and focus on. Issue One: Standard Deviation and Expected Return

The following assets will be evaluated on riskiness according to the calculations of expected returns, standard deviations, and coefficients of variations. These calculations portray the probability of the data and give us a decent idea of where and how the assets are distributed. According to the results of our calculations, in order from least risky to most risky, the assets rank as follows: T-Bills, Market, Outplace Inc., and Games Inc. Using the coefficient of variation in determining risk can prove to be a benefit because it allows the comparison of different investments. An advantage of using standard deviation to measure of risk is that it provides an indication of how far above or below the expected rate of return the actual return is. The asset with the larger standard deviation is considered riskier because it has larger dispersion of expected returns—hinting that the actual return may be significantly lower than the expected returns. However, measuring risk with standard deviation and CV can also be a disadvantage because it does not allow a multi-faceted analysis of the assets. Standard deviation can also serve as a disadvantage because it cannot be used to compare investments unless they have the same expected return. If the data for an index fund were designed to mirror the market, the best guess would indeed be that the expected return and standard deviation would equal the market as long as the assets in the index are comparable to the market. Issue Two: Implications of Investment Risk

The investment risks of these securities are relatively low because of the equilibrium involved in the portfolio. Since each investment consists of 50% of the portfolio the effects of each security is balanced because they are negatively correlated. For instance, since Outplace Inc. performs well in the a poor economy and Games Inc. performs poorly in a poor economy, the mix of the two securities in a portfolio involves less risk because the companies can compensate for each other and cannot fall to the same extent at the same time. This portfolio includes diversification and therefore involves a more safe investment. Issue Three: Evaluating Asset Risks

Each of these statistics components has value together in determining and evaluating the assets risk. Standard deviation is a statistical element that portrays historical volatility. A large dispersion indicates how much the actual returns are deviating from the expected returns. The higher the deviation, the more risky the investment is. Beta coefficients measure a stock’s volatility in the market relative to the S&P 500 and represent a great way to gauge risk. When looking to evaluate an assets risk, one should seek out securities with a beta coefficient of less than 1.0. Beta involves the tendency of securities returns in response to swings in the market and...
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