Security Market Line and Beta Paper
Risks are everywhere, however that does not mean one has to resort to accepting all levels of risk in the world. Risk is identifiable and as such can be mitigated down to a level where an individual is comfortable with or at the least tolerant of the risk. The stock market requires the use of an individual or business investor’s money and therefore involves considerable amounts of risk. Those who are averse to risk, yet can see the benefits of investing, must due their due diligence prior to investing in a stock that may be considered risky. By using beta and the security market line as tools to identify risk in the market, investors are able to mitigate risky decisions and build a comfortable portfolio that
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Beta determines the risk a stock provides to a portfolio. Beta is the measurement of stock risk by using the standard deviation of the stock return, standard deviation of the market return, and the correlation between the stock and market returns (Brigham & Ehrhardt, 2015). Beta uses past data to determine future risk. However, in order for this prediction to be precise, the data behind the calculation must be stable for several years prior to the calculation (Terceño, Barberà-Mariné, Vigier, & Laumann, 2014). A beta higher than one represents higher risk when compared to the market average, and a stock with a beta of less than one represents a lower risk (Brigham & Ehrhardt, 2015). By using this risk calculation, an investor can compare betas of various stocks to determine the amount of risk they are comfortable with in the …show more content…
First of all, the SML equation solves for the required return on stock by using the risk-free rate plus the product of the beta of the stock and the market risk premium (Brigham & Ehrhardt, 2015). For example, an investor is comparing stocks available for purchase from Johnson Manufacturing and Dyer Industries. The betas for the stocks are 1.0 and 1.5 respectively, the risk-free rate is 6%, and the market risk premium is 5%. The required rate of return for Johnson Manufacturing is 11% and the required rate of return for Dyer Industries is 13.5%. Due to the lower risk or beta of the Johnson stock, the investor would expect the rate of return to be at 11%. This example shows that increased risk requires increased
By focusing on only one risk, for example peer risk, it leaves the company up for even more risk in its assets and pension obligations. Figure 1 illustrates that these risks do indeed rely on one another. When investors try to only minimize one of the risks (small circles) stockholders leave themselves open / exposed to the other two scopes of risk: Beta and Matching (ALM).
The Smith & Wesson Holding Corporation stock has an EPS of 1.42 and a P/E ratio of 10.52. Upon running a regression, a coefficient of 0.139 was calculated. This means that if the SWHC stock increases by 1%, the S&P 500 stock will increase by 0.139%.When compared against the S&P 500 index, the SWHC stock has a correlation of 16.3%. This is relatively low. The SWHC stock can explain approximately 16.3% of the variation in the S&P 500. In other words, the stock does not behave the same as the S&P 500 and should not be used to predict the S&P 500. There is about 83.7% of the...
Before we invested, we decided to pick two types of companies to invest in. We would choose companies that had expensive stock but steady increasing prices and we would choose smaller companies that had cheaper stock but whom had a chance for potential huge price increases. If the smaller companies’ stock went down the bigger companies’ steadily increasing stock would even it out, but if the smaller companies’ stock price rose greatly, like we predict, we could sell and make a good profit. We found a big name company that had reliable stock prices pretty quick, but finding a small company whose stock price could rise was hard. We
When determining whether to merge or partnership with another hospital is a beneficial choice, one will need to review financial information to make an informed decision. According to Cleverly, Cleverly, and Song in order to make effective decision it requires adequate knowledge and interpretation of financial information. Understanding the accounting processes of business decisions results in effective operational decisions (2012). Some of the financial statements that are used to make these decisions are income, itemized, balance statements, net assets, and cash flow.
Fama and French findings shocked the modern portfolio theory and their study was nick named "Beta is Dead". With respect to CAPM they found that stocks with high betas did not have consistently higher returns than low-beta stocks. Furthermore, Fama and French concluded that a high book value to market value was the most important variable related to predicting high stock returns on small cap stocks. These findings were published in a 1992 paper titled "The Cross-Section of Expected Stock Returns".
The Power of the Market by Milton and Rose Friedman is about central economic planning and the relationship between the government and its role in the economy. Economic freedom “and essential part of economic freedom is freedom to choose how to use our income: how much to spend on ourselves and on what items; how much to save and in what form; how much to give away and to whom.” “Currently, more than 40 percent of our income is disposed of on our behalf by government at federal, state, and local levels combined.” Is that really freedom? In reality there is no economic freedom, the government controls it. They have their hands in almost everyway possible to make money off of every American. We are nothing but “customers” who work hard to survive while the government has their hands in our pocket every step of the way.
What was the nature of the urban and market development during the mid-19 century? This refers to the term the “Market Revolution”, for the many economic and social changes that occurred between 1812 and 1860s (Schultz, 2010). During a time when an enormous number of farmers chose to avert from being self-sufficient to focus on a single growing crop that could be sold at the market from assistance by an abundant transportation, communication, and technological innovations.
In your response, build upon extant portfolio theory and make sure to talk about different types of risks that investors might face and how they go about managing such risks. This means you need to consider topics such as efficient frontier and optimal portfolios; as well their relevance to investment theory. Furthermore, given the nature of the assignment, avoid bringing the brokerage industry into your discussion. In other words, assume you can invest directly in the stock market and do not need any financial intermediaries like brokerage houses.
Capital Asset Pricing Model (CAPM) is an ex ante concept, which is built on the portfolio theory established by Markowitz (Bhatnagar and Ramlogan 2012). It enhances the understanding of elements of asset prices, specifically the linear relationship between risk and expected return (Perold 2004). The direct correlation between risk and return is well defined by the security market line (SML), where market risk of an asset is associated with the return and risk of the market along with the risk free rate to estimate expected return on an asset (Watson and Head 1998 cited in Laubscher 2002).
According to Investopedia (Asset Allocation Definition, 2013), asset allocation is an investment strategy that aims to balance risk and reward by distributing a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. There are three main asset classes: equities, fixed-income, cash and cash equivalents; but they all have different levels of risk and return. A prudent investor should be careful in allocating each asset class to his portfolio. Proper asset allocation is a highly debatable subject and is not designed equally for everybody, but is rather based on the desires and needs of the individual investor. This paper discusses the importance of asset allocation, the differences and the proper diversification within the portfolio.
How might finance help to cure depression? This may look like an absurd question at the first sight, but it happens to me that the logic behind finance actually aids me to treat my depression. I used to be a perfectionist who tries to take the very control of my future, and could not tolerate any tiny failure. Although I performed well in most cases, I always paid more attention to what I did not achieve. Meeting with psychotherapists did not treat my depression well because those sentimental psychological theories could hardly persuade me until I come across finance, whose rough numbers and rational logic are much more convincing to me. The most impressive example is the concept of Sunk Cost. It taught me that whatever I failed to achieve in the past, it should no longer worry me and I should focus on current conditions and make wise decisions as possible from the very moment on. Other concepts such as NPV also provide me with brand new perspectives to see my life in a more optimistic way. Finance becomes more interesting when I am able to see beyond finance itself. By linking finance to my situation, I have learned more about how to live a happier life, which gives me more fun while working.
... while using the beta approach as a guide. Returns may also rely on general market swings, changes in interest rates and inflation, to changes in national income and other economic factors.
between two separate entities. One of these bodies gives, to the other, use of their money for a
Japan has one the most advanced economies in the world, with an advanced economy comes an advanced equity market. As other advanced equity markets are, the Japanese market is similar to the U.S. in its essential functions and its operation by the exchanges that allow its existence. The Japanese stock market is third largest in the world by market capitalization, surpassed only by the United States and China. Market participants trade over the Tokyo Stock Exchange and the Osaka Securities Exchange which combined to form the Japan Exchange Group (JPX) in 2013 (JPX.com). As of November 2015 there were 3500 companies listed as part of the JPX and over $400 billion dollars of shares traded in 2014 (World Federation of Exchanges).
The Modern portfolio theory {MPT}, "proposes how rational investors will use diversification to optimize their portfolios, and how an asset should be priced given its risk relative to the market as a whole. The basic concepts of the theory are the efficient frontier, Capital Asset Pricing Model and beta coefficient, the Capital Market Line and the Securities Market Line. MPT models the return of an asset as a random variable and a portfolio as a weighted combination of assets; the return of a portfolio is thus also a random variable and consequently has an expected value and a variance.