Investment Risk and Beta Explained

¶ … measure risk? Risk is a "yin" to the yang of investment, which would be performance. In a nutshell, risk is a deviation from the standard and expected outcome. In other words, let us say there is the expectation that a certain stock will keep soaring. Risk is the perceived or actual probability that this will not happen. The usual tool and metric used to measure risk is standard deviation. Standard deviation is the measure of how far from the norm or average that a stock or other investment performs.

What are the different types of risk affecting the securities and portfolios held by individuals and corporations? Discuss In general, there are two types of risk, those being active and passive. The common measurement that comes forth when it comes to measuring risk is the "beta," which is basically another way of saying how volatile the security or how likely it is that the security's performance will deviate from the "norm" for the market as a whole. Other names for the beta include market risk, systematic risk or non-diversifiable risk.

Risk can also come in the form of completely ad hoc or one-off events such as terrorism or an unexpected political shift (Investopedia, 2016). A recent example of the proverbial apple cart getting upended was the recent decision of the British voters to leave the EU. While the vote was expected to be close, the odds of them choosing to leave was deemed to be very low.

However, "leave" was triumphant and the British pound, just to name one thing, has dropped like a rock in terms of value since the vote's results were revealed. There may very well be a correction back up coming soon but it has not happened yet (Kantchev, 2016). 3) What are the different types of risk affecting the operations of corporations? Explain. There are many, but there are some that are more prominent than others. For example, an unexpected shift in interest rates or currency valuation (e.g.

the Brexit fervor) can hurt a business that is knee-deep in investments that rely on interest. Indeed, this would be many investments such as bonds, preferred stocks or anything with a fixed rate of return. Beyond that, bonds bought or issued by a company can always go belly up and the risk of those bonds, regardless of who issues them, will have an effect on interest rates.

Just as a consumer with shoddy credit will pay a higher interest rate, the same is true of bonds for companies with stability/cash-flow issues. Businesses have to worry about other things like liquidity issues (spendable cash versus having non-cash assets or assets that are not easy to convert to cash), social/political issues, law changes, etc. (Investopedia, 2016).

4) In the real world, is it possible to construct a portfolio of stocks that has a positive expected return with standard deviation of returns equal to zero -- a no risk portfolio? No. Some people assert this but there is always a modicum of risk when it comes to investments. Even stuffing money in a safe or under the bed is a risk because inflation can make the cash worth less or the money can be stolen.

Even putting the money in a low-interest or no-interest savings account is risky because of the same inflation just mentioned and how relatively easy it is to make at least somewhat better income with little to no additional risk (Investopedia, 2016). 5) What is Beta? What is its application in financial management? Is Beta stable over time? If not, explain why. As explained earlier when it came to risk, a beta is the measurement of volatility, otherwise known as systemic risk.

Beta does NOT remain the same over time as things are always changing and moving. Just one reason is that a beta would change just by changing the time window that is being looked at. How stable the market or a given security is for one month may be very different than how stable it is over a year.

Indeed, a stock may start and end a year at the same price but there was obviously at least some movement in between times and the corresponding events that caused or influenced those.