Two of the most important factors that any company should consider in its financial analysis are risk and return. Risk is a measure of the uncertainty around the return an investment will earn. That is, investments whose returns are more uncertain are considered riskier. There are different methods to assess risk depending on whether a single asset or an entire portfolio is analyzed. In contrast, the total return is the total profit or loss of an investment in a certain period of time. Yield is the sum of all cash distributions plus the change in investment value, between the initial investment. Returns fluctuate over time and investment. Three categories are used to describe how people react to risk:Risk aversion is to prefer investments with less resistance to higher risk investments with a fixed rate of return, risk neutral is to choose investments considering only returns while ignoring risk, and, finally, risk seeking is to choose investments with the highest risk willing to sacrifice expected return.
Single asset risk
A simple way to measure the uncertainty of an investment is through sensitivity considering different scenarios. Investment risk is measured in the range of possible outcomes obtained, and is obtained by subtracting the return associated with the pessimistic scenario from the return associated with the optimistic scenario. That is, the longer the interval, the greater the risk. Another method is through probability distributions. The probability of a given outcome is its chance of occurrence, that is, outcomes with zero probability will not occur. This distribution is represented mainly through graphs. If all possible data and their probabilities are known, a continuous probability distribution can be developed.In conjunction with the range of returns, risk can be measured using the standard deviation. This measures the dispersion of the return around the expected return, which is the average return that an investment is expected to produce over time. The higher the standard deviation, the greater the risk. Using this tool and graphing, a normal probability distribution has a symmetric curve. Another method is the coefficient of variation (CV), which measures relative dispersion to compare the risks of assets with different expected returns. A high ratio means that the investment has high volatility relative to its expected return.which is the average return that an investment is expected to produce over time. The higher the standard deviation, the greater the risk. Using this tool and graphing, a normal probability distribution has a symmetric curve. Another method is the coefficient of variation (CV), which measures relative dispersion to compare the risks of assets with different expected returns. A high ratio means that the investment has high volatility relative to its expected return.which is the average return that an investment is expected to produce over time. The higher the standard deviation, the greater the risk. Using this tool and graphing, a normal probability distribution has a symmetric curve. Another method is the coefficient of variation (CV), which measures relative dispersion to compare the risks of assets with different expected returns. A high ratio means that the investment has high volatility relative to its expected return.Another method is the coefficient of variation (CV), which measures relative dispersion to compare the risks of assets with different expected returns. A high ratio means that the investment has high volatility relative to its expected return.Another method is the coefficient of variation (CV), which measures relative dispersion to compare the risks of assets with different expected returns. A high ratio means that the investment has high volatility relative to its expected return.
Risk of a portfolio
The goal of every financial manager is to create an efficient portfolio that gives a maximum return at a certain level of risk. The performance of a portfolio is calculated through the weighted average of the returns of the individual assets of which it is integrated. The standard deviation of a portfolio's performance is calculated through the application of the standard deviation formula for an asset. Correlation is a measure of the relationship between two series of numbers that represent any type, statistically. If the series vary in the same direction, they have a positive correlation. Otherwise they would have a negative correlation. The degree is measured by the correlation coefficient, which ranges from +1 (perfect positive correlation) to -1 (perfect negative correlation). To reduce the risk of a portfolio,it is convenient to diversify the assets that compose it so that they have as low a correlation as possible. Some assets are considered uncorrelated, meaning that there is no interaction between their returns and it reduces risk. The correlation coefficient of this is close to 0. In general, it can be said that the lower the correlation between the assets that make up the portfolio, the more the risk that investors can achieve with diversification is reduced. A very practical example of diversification is a portfolio that includes foreign assets, since the ups and downs of the markets around the world offset each other. However, there are certain risks such as fluctuations in currencies, as well as political risk that may affect locally or globally.
Capital Asset Pricing Model (MPAC / CAPM)
The theory that relates risk and return on assets is the MPAC or CAPM model. It has already been seen that the standard deviation of a portfolio is often less than the standard deviation of the assets that comprise it. The total risk is obtained with the sum of the non-diversifiable risk, which is attributed to market factors that affect all companies that are not eliminated through diversification, and the diversifiable risk, which is attributed to fortuitous causes and it can be eliminated with diversification. The MPAC model relates risk that is not diversifiable to expected returns. The model is composed of five parts, the first being the beta coefficient. The beta coefficient is the index that represents the degree of movement of the return of an asset in relation to the degree of movement of the market,that is, all the securities listed on the stock market, the coefficient of this being 1.0. The higher the beta coefficient, the higher the required performance. The second part is the model equation, which is obtained by subtracting the market return minus the risk-free rate of return, multiplied by the beta coefficient, all of this added to the risk-free rate of return. The third part is the chart of the MPAC model, and this representation is called the stock market line (LMV). The LMV is a straight line, and the risk of the beta coefficient is represented on the x-axis, when the required return is represented on the y-axis. The fourth part is the changes that may affect the LMV. The position and slope change mainly due to two factors: inflation expectations and risk aversion.Changes in inflation expectations cause changes in the risk-free rate of return. The slope of the LMV shows the degree of risk aversion. The steeper the slope, the greater the degree of risk aversion. Finally, the fifth part is some comments regarding the MPAC model. Beta coefficients may or may not reflect future variability of returns, as they take present and past data for their calculation. The MPAC is based on the assumption of a market with many small investors equal in expectations in relation to the values, with no restrictions on investments, no taxes or transaction costs, and rational investments, that is, with a tendency to higher returns and lower risk.
