Risk and Return Analysis
Introduction
There are various different financial products that one may choose to invest. Each financial product has its special features. Some of the investments have low risks and thus the return is also low. Others have high risks but offer you high potential returns. Returns are the gains or losses from security in a particular period and are usually quoted as a percentage (Carpenter, 2009). The kind of returns investors expect from capital markets are influenced by some factors like risk. The risk is the chance that an actual investment return will be different from expected (Bouleau, 2011). Risk can also be defined as the possibility of losing some or even more of an original investment.
Risk-Return Trade-Off
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Stocks do put forward possession in a company while bonds are loans made to an organization. They are a form of debt, and they do appear as liabilities in the organization. There are different kinds of stocks and bonds to choose from, some of which are better to invest in than others. Stocks do fall into common stock and preferred stock. The majority of investors deal with common stock. Under common stock its one of the easiest due to several factors which includes a variety of different types of companies stocks that is good and diversified portfolios. The bond market, which is also known as the debt or credit market, always allows investors to issue new debt in the primary market and then buy and sell debt securities in the secondary market (Choudhry, 2001). Companies usually issue bonds and shares in common stock to raise capital. Bonds are the loans from bondholders issued to the public as well as the private investors. The bondholders receive fixed periodic interest payments and get the principal back on maturity. You can deal with the stock and bonds directly as regulated and over-the-counter. On the other hand, one can choose to invest circuitously in trust funds. Public-sector bond issuers include the Treasury, which issues short-term bills and long-term bonds, state and local governments, which issue municipal …show more content…
During the economic and market uncertainties, investors may rotate their funds out of stocks and into the relative safety of bonds Based on income, the advantage of bond holding is the periodic interest payment. For instance, given a 1000 dollars par value bond, 5% coupon pays $50 interest annually.
Certain bond investments provide tax advantages. Interest payments on U.S. government bonds are not subject tax both at the national level and metropolitan stage. consequently, Treasuries may be forced to offer certain tax reimbursements to people living with high personal earnings. Notably, the municipal bonds are exempt from federal taxes and local taxes. They are also exempt from state taxes in the state in which they are
The financial challenge in the managing risk simulation was to balance between preserving capital and capital appreciation in the investment of funds based on a persons’ risk tolerance. The simulation targeted the stock mix for a client’s aversion to risk and the ability of the investment portfolio to have an expected rate of return. The prediction of fund future prices acted as a hedge and had an impact on the rate of return depending on the changing financial landscape of a company. The overall effect was to juggle the mix based on past history and predict a future outcome.
Investing in stocks involves owning part of a company’s equity which effectively enables the shareholder to receive a portion of the company’s earnings and assets in form of dividends. Stocks are generally categorized as either common stocks or preferred stocks whereby common stock allow investors to vote on key issues but do not guarantee of dividends (Markowitz 78). Preferred stocks on the other hand do not provide voting rights but assure stockholders of dividend payments. Investing in stocks offers investors comparatively high returns relative to treasury securities but the investments also have high inherent risk. Stocks are purchased through licensed stockbrokers who range from the discounted order-taking online brokers, to the pricey full-service brokers and money managers (Sourd 112). Despite the type of broker an investor opts for, the stock market has the potential to generate high returns through an investment strategy. One of the main strategies employed is diversification which involves the purchasing of different stocks with varied performance and rates of returns in order to spread out the risk of the individuals stocks across a portfolio. Investing in stocks is therefore one of the most profitable alternatives of personal financial planning, and should be considered as one of the investment vehicles that generates an additional income stream.
A bond is debt to whoever sells the bond to an inventor. If you buy an IBM bond, you are loaning money ($1000) to IBM instead of a bank loaning money to them. Just like a bank, you are going to charge IBM interest on your money, as well as a return of principle when the loan is due (ten years later). The company does not go to the bank to borrow the money, because the bank will rate the company as a high risk company. Hence, banks are really tight with their money. High yields bond investment relies on an credit analysis in that it concentrates on issuer fundamentals, and a "bottom-up" process. It focuses more on "downside risk default and the unique characteristics of the issuer. In a portfolio of high yield bonds, they are diversified by industry group and issue type. Due to the high minimum size of bond trades, most individual investors are best advised to invest through high yield mutual funds.
The Financial Crisis of 2007-2009 was one of the hardest financial times in the United States since the Great Depression. This was a time where many financials institutions failed, housing markets collapsed, and when banks had to be bailed out by the government. This caused the unemployment rates to increase, homes to be foreclosed, and the interest rates to fall. With all of these different systems failing, it raised concerns for many investors if their money was safe in Money Market Mutual Funds.
What is a bond? Bonds are often considered by investors to be “financial IOU's.” Frequently, bonds are issued from banks designed for quick, upfront cash used in lending purposes, such as loans. When purchasing a bond, the buyer pays an upfront sum of money to the seller. By the terms and conditions...
Dividends is used often with the stock market, dividends are profit you receive when the company makes a profit. If the company does not make a profit, you will not receive a dividend reimbursement. Payments can be reinvested, which helps build wealth because you are increasing your portfolio. You can also so use this cash for whatever you like.
Market Risk is also known as Systematic Risk due to its broad impact on investments. The level of Market Risk depends on the probability that the entire market will decline and drag down the values of all companies. With Market Risk, investors stand to lose value irrespective of the companies, business sectors, or investment vehicles they are invested in. It can be difficult for investors to protect themselves against market risk, since investment strategies, like diversification, is mostly ineffective (Investopedia,
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.
A stock is a share of a public corporation that is traded in the open market. It is how a corporation raises its’ capital to expand their business and ability to produce goods or services. There are two types of stock: common and preferred stocks. The difference is how an investor receives a dividend. Both stocks give a person a piece of ownership of a corporation with the hope that there is a return on their investment.
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).
Hensel, C. R., Ezra, D., & Ilkiw, J. H. (1991). The Importance of the Asset Allocation Decision.
What is the role of investor’s confidence in the financial markets? Why a downgrade of the US treasury sends ripples in the stock markets all over the world .How do investors react to such kind of information? Do we take all the information into account before...
...ed to consult a broker to purchase company shares. It is always important to research the company you are thinking of investing in thoroughly. It is best to hold onto stocks for a long time as there are fees when buying or selling, and the tax implications that will apply. Bonds are usually safe investments and are often backed by the federal government.
Using the Modern Portfolio Theory, overtime risk assets will provide a higher expected rate of return, as compensation to the investors for accepting a high risk. The high risk will eventually lower collecting asset classes to the portfolio, thus reducing the volatile risk, and increasing the expected rates of return. Furthermore the purpose of this theory is to develop the most optimal investments portfolio which would yield the highest rate of return while ascertaining the risk for the individual or corporate investor.
2. Coupon rate( It is the nominal interest rate that the issuer pays to the bondholders. The bondholder will received return in the form of coupon instead of dividend. It could be pay monthly, quarterly, semi-annually, or annually. However, most bonds pay every semi-annually (six months).