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Articles by Probir Banerjee
Page 34 of 45
Does diversification reduce the risk in investment?
Diversification in InvestmentIf the market conditions are normal, diversification is an efficient way to reduce risk. Holding just one type of investment can potentially pose a threat to your investment if the securities of your industry fail. In such conditions, you could lose all of your money. A well-diversified portfolio with a variety of different investments will save you when one investment performs badly in the market. As it is unlikely that all of the investments will perform badly at the same time, the profits you earn on the investments of other assets that perform well will offset the losses ...
Read MoreWhat is Unsystematic Risk in Finance?
Unsystematic risk is related to the internal risk factors of the organization. It is also called specific risk, idiosyncratic risk, diversifiable risk, or residual risk. An unsystematic risk occurs due to any event for which the business is not prepared, and which disrupts the general and smooth functioning of the firm’s business.Some of the factors that lead to unsystematic risk are −The inefficiency of the managementChanges in the capital structureLiquidity crunch in the businessFlaws in the business modelProduction of non-desirable productsLabour strikesUnsystematic risk can be diversified and so can be avoided. It is a fact that one can diversify their ...
Read MoreHow to use the Characteristic Line to measure the risk and return of a security?
A Characteristic Line (CL) measures the risk and the related return of a security. The returns of a security at different times are plotted on a line that takes a form of a straight line which is the characteristics line (CL).The CL represents the performance of the security in comparison to the market risks. The stock returns are placed on the Y-axis of a graph and the stock market returns are placed on the X-axis. The beta coefficient of the graph provides the slope of the characteristic line. The slope and standard deviation of the characteristic line, define the asset’s ...
Read MoreWhat is Systemic Risk in Finance?
The risk that occurs due to the system of economy is known as systematic risk. Systematic risk is complex in nature and is beyond the control of an individual or a specific company. In general, all investments and securities are prone to such kinds of risk.Systemic risk includes unforeseen events that happen automatically, making it uncontrollable and beyond the will of a single person or company. Systemic risk usually impacts the entire industry rather than a single company or security.Note − Systemic risks cannot be avoided by diversification.Example #1: The 1866 Overend and Gurney CollapseOverend and Gurney was a brokerage ...
Read MoreWhat is Capital Allocation Line?
Capital Allocation Line (CAL) and Optimal PortfolioThe Capital Allocation Line (CAL) is a line that shows the risk-and-reward profile of assets and can be utilized to build an optimal portfolio. The process of building the CAL for a set of portfolios is given below.Portfolio Expected Return and VarianceLet’s construct a portfolio with only two risky assets for the sake of simplicity and understanding. The portfolio’s expected return is the weighted average of each individual assets’ expected returns, and is calculated as −$$\mathrm{𝐸(𝑅_{𝑝}) = 𝑤_{1}\:𝐸(𝑅_{1}) + 𝑤_{2} \:𝐸(𝑅_{2})}$$Where$𝑤_{1}$ and $𝑤_{1}$ are the weights for the two assets, and$𝐸(𝑅_{1})$ and $𝐸(𝑅_{2})$ are ...
Read MoreWhat is a risk-free asset?
A risk-free asset comes with a virtually guaranteed return. Usually, all investments have a degree of risk associated with them, so the term "risk-free" is used to mean the assets that are sufficiently safe so that investors can remain sure to get a return on their investment that is somehow close to the return predicted for the asset while investing.A risk-free asset has a definite future return, whatever the risk of the assets is. This type of asset often provides a certain return providing investors a level of assurance over the return from the.The United States Treasury Bills are a ...
Read MoreHow to calculate Arithmetic Average Return?
The Arithmetic Average Return is calculated by adding the rate of returns of "n" sub-periods and then dividing the result by "n". In other words, the returns of "n" sub-periods are added and then divided by "n" to find the value of the average return. As it is also the process of finding the average of a series of numbers, the average return is sometimes called as "Arithmetic Average Return".Here is the formula to calculate Arithmetic Average Return −$$\mathrm{Average\:Return =\frac{Total\:Value\:of\:the\:Return}{Total\:Number\:of \:Returns}}$$Investors and market analysts normally use the arithmetic average return to check the past performance of a stock. It is ...
Read MoreWhat constitutes a return on a single asset? How is it calculated?
The typical reason for an investor to invest in a financial instrument is to make current income from dividends and interest income. For a stable company, the investments will earn a reasonable return that is the Expected Rate of Return (ERR) on given investments. Some investments such as debentures, bank deposits, public deposits, bonds, etc. carry a predetermined fixed rate of return that is usually payable periodically.Note − The sole aim of the investor investing in a single asset is to get the maximum returns. Some fixed income instruments offer less returns, but they are less risky too. Increasingly risky ...
Read MoreWhat is meant by Present Value of Growth Opportunities (PVGO)?
Present Value of Growth Opportunities or PVGO represents the component of a company’s share value that relates to expectations of the investors in the growth of earnings. PVGO is the difference between the total value of a company’s shares from which the net present value of its earnings is deducted, assuming there is no growth in the values of the share. PVGO is also known as "value of growth".A company’s future income can be better represented in two layers: the first layer represents a perpetuity having constant return and the second layer represents the future growth in earnings.$$\mathrm{𝑉_{0} = PV_{NG} ...
Read MoreHow is the expected return on a portfolio calculated?
Rather than taking each rate of return and multiplying them with the weight to get the total weight of each asset, there is a simple formula to calculate the expected rate of return. The expected rate of return of a portfolio or simply the return of a portfolio is the given weighted average of the expected returns on the assets.ExampleLet's take an example of a two-asset portfolio and see how to calculate its expected return. Let’s assume an investor has invested 50% of his investment in X and 50% in Y.$$\mathrm{ERR\:of\:Portfolio = (Weight\:of\:Security\:X × 0.5) + (Weight\:of \:Security\:Y × 0.5)}$$Note ...
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