How Can Risk Influence Risk Premium? How Are Risk and Return Related?

The idea of “risk” is used in many fields and industries. There has been large efforts made towards the understanding of risk. Since, risk varies so much depending on the field of study, the need for learning about it is warranted. As can be imagined, the importance of risk in a market economy is crucial. In the 1990s, JP Morgan made the Value at Risk (VaR) a central component of its work efforts (Cecilia-Nicoleta, Anne-Marie, & Carmen-Maria, 2011).

“The Benefits of diversification are clear. Portfolio theory has played a crucial role in explaining the relationship between risk and return where more than one investment is held. It also enables us to identify optimal and efficient portfolios.”

magnitude of these risks, this paper advocates for a more proactive solution. Active investing in

IF the required rate of return increases from 8.1% to 10% then the current share price of common stock with decrease from $21.41 to $18.33. As the price of the stock increases this can be riskier for the investor. But with higher risk the returns should be higher as well with dividends. If the dividends are higher this can boost the confidence of others to buy more stocks as there are good returns with the company.

Defined by Coopers textbook, risk is the exposure to the consequences of uncertainty and has two elements: the likelihood of something happening that has an impact on the project objectives, and the positive or negative consequences of something impacting the project objectives (Cooper, Grey, Raymond, & Walker, 2005)

Based on the dividend discount model, P0 = D0 * (1+g) / (k – g), then we get the return rate (the cost of equity) k = D0 * (1+g) / P0 + g = 0.48 * (1 + 0.055) / 42.09 + 0.055 = 6.7%

Of the many risk profiles that exist, namely: cash profile, conservative profile, moderately conservative profile, growth profile, and high growth profile, I would settle on balanced profile in allocating assets because an investor would want to steadily grow his investment over time (Bailey & Kinerson, 2005). I will be comfortable taking on a greater level of risk to achieve this. With the balanced profile I will be capable of placing more of my investments into growth assets. This will increase the possibility of rises and falls to my investment value. The possibility of a negative return would be very remote with the balanced profile. This type of asset allocation creates a balance between seeking capital for growth and wealth preservation (Bailey & Kinerson, 2005). With the balanced risk profile, an investor accepts the risk in the pursuit of long term gain. With the balanced risk profile an investor seeks reasonable level of returns and accepts a medium level of risk. This kind of asset allocation makes an investor to accept the possibility of losses from time to time while he expects growth in assets over the medium to longer term (Bailey & Kinerson, 2005). With a balanced risk profile an investor will have a balanced allocation between stable "income" investment assets such as cash and fixed interest and their allocation to more volatile growth investments such as shares and property (Bailey & Kinerson, 2005). Balanced risk profile is suitable

The goal of finance is to find the optimal enterprise solutions that balance expected return and expected risk. We can find and implement the optimal solutions by using financial information, tools, and models. In finance we want to reduce expected risk and increase expected return, but since getting rid of risk entirely is impossible we look for the best combination of the two.

Whether it is investing, driving or just walking down the street, everyone exposes themselves to risk. Your personality and lifestyle play a big role in how much risk you are comfortably able to take on. If you invest in stocks and have trouble sleeping at night, you are probably taking on too much risk. (For more insight, see A Guide to Portfolio Construction.) Risk is defined as the chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment.

Risk management is defined as the effort to avoid, reduce, control, or mitigate the risks deemed unacceptable. Uncertainties

Common Risk Factors in the Retu rns on Stocks and Bonds Eugene F. Fama Kenneth R. French Journal of Financial Economics 1993 Presenter: 周立軒 Brief Saying… • This paper identifies Five common risk factors in the return on stocks and bonds – Two stock market factors, two bond market factors , one market factor. – The five factors seems to explain all returns in stoc k market and bond market • Except the Low-Grade Bonds  Agenda • • • • • Introduction The Steps of the Experiment Data & Variables

Conversing with fellow investors over the last few days, I often discouraged an extremist approach to investments, i.e. holding uncompromising views of a security’s rise or fall. Instead, I promote a more evolved approach that takes into account all the circumstances (including risks), and then decides whether the security truly represents an investment-worthy candidate. In doing so, an investor prepares himself for different outcomes, which helps him manage his risk more effectively.

In their research study, Souder & Myles (2010) identify that risk is chiefly fundamental to investing. Böhringer & Löschel (2008) further add that there is no discussion of returns or performance that is deemed meaningful in the absence of at least some mention of the involved risk. However, the trouble for investors, who have just entered into the marketplace, involves the process of figuring where risk really lies, as well as what the difference between the various levels of risks. Relating to the manner, in which risk is fundamental to investments, a significant number of new

The phenomena behind equity risk premium discussion for 35 years, was first took place in Robert J. Schiller’s work done on volatility of equity prices. The research conduct by Schiller (1982), highlighted the difficulty of explaining the historical volatility of stock prices. The results of Shiller’s paper stunned the profession at first as most of economists felt discount rates were close to constant over time. The intuition behind the unpredictability of volatility, later named volatility puzzle by scholars who have studied this paradox as well. Just after 3 years from Schiller work on historical volatility, Mehra and Prescott (1985) introduced the equity premium puzzle. It is mainly based on the lack of evidence for a high risk premium in terms of consumption growth. In other words, investors require and have high returns which have low covariance with consumption growth. Using Schiller’s data collected on the volatility puzzle, they have found out that between 1889 and 1978, the consumption growth rate, the indicator for opportunity cost of investors is insufficient to explain 6% risk premium. Moreover, it was so high that the findings suggested only a risk premium of 0.35% on top of the risk-free rate. Behavioural finance approached this puzzle based on preference of investors. The decision making process of investors on investing on equities and why do they require high risk premium and fear equities this much. One of the leading papers on the

Risk is a probabilitic value. The notion of risk is considered as probability of happening of adverse events, and the risk can not be completely eliminated. The risk can be only reduced. In financial management elimination of the risk is meant as its maximum reduction (minimization). The portfolio, which neutralized the risk caused by a particular event, called for a balanced portfolio against the risk.