Risk Factor Based Portfolio Investment Strategies

The table below shows the equity betas for the firms presented in the case (using Jan-92 to Dec-96 equal weight NYSE/AMEX/NASDAQ as market portfolio):

“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.”

Risk refers to any potential problems that would threaten the likelihood of success for or any project. These potential problems might prevent a project from achieving some or all of its objectives by increasing time and cost. Risk factors can even

Risk: A risk is the chance, high or low, that any hazard will actually cause somebody harm. (the likelihood of it happening).

4. If the slope of the line measuring a stock's historic returns against the market's historic

Systematic risk or market risk is the risk that affects a large number of assets. Examples of systematic risk are inflation or increasing the interest rate, or any uncertainties in the economy but not the company 's performance. Unsystematic risk is the risk that mainly associated with specific companies or may be some competitors and suppliers. The systematic risk affects the whole market and cannot be controlled by investors. Unsystematic risk however affects the company and is controlled by the company 's performance. When investors invest money into a company they must research all aspects of that company so they are aware of the unsystematic risks they may encounter.

Risk refers to a likelihood, probability, a chance that a loss may occur in a given organization. Most of the times, there is a high risk when there is vulnerability. In this case, vulnerability refers to a weakness that the organization has. Risk assessment refers to the process of identification of potential hazards and proper analysis of the expected losses if those hazards occur (Homeland Security, n.d.). Risk assessment as a way of profiling risk according to impact to the organization. Some organizations have business impact analysis exercises geared towards determination of potential hazards based risk assessment approaches. Organizations’ risk differ depending on the size and the type of business they are doing. The disparity in organizations’ risk call for different adaptation of risk assessment approaches. Even with the disparities of the businesses, proper risk management not only ranks the risks according to the seriousness but also identifies the best methods to control risks in an organization.

Portfolio management supports an organization’s mission and goals by ensuring the program is managed properly and the timing is on a set schedule. Portfolio management supports the accomplishments and the preferred outcomes. The tools and techniques involved assist with the efficiency and the effectiveness. The portfolio management supports in the organization utilizes the resources where they can be applied throughout the organization. Portfolio management assists with creating the operational needs throughout the period of the project. The portfolio management achieves with the vision, mission, and goals and even identify the risk. The time cost and all resources that would be required help identifying within the goals.

We use the equation ri=(Pt-Pt-1+Dt)/Pt-1 to calculate the monthly return of stock of Charles Schwab Corp, Quick & Reilly Group and Waterhouse Investor Srvcs. Then we have two methods to calculate the Beta of Equity for each company.

To find the asset Beta (βa), we need to find the weighted average β of equity and the weighted average β of debt. We consider the β of debt to be 0, as debt has no relationship with market risk and it is evident from the balance sheet that Ameritrade had no interest bearing debt in 1997[1].

To reduce a firm’s specific risk or residual risk a portfolio should have negative covariance or rather it should have no variance at all, for large portfolios however calculating variance requires greater and sophisticated computing power. As such, Index models greatly decrease the computations needed to calculate the optimum portfolio. The use of such Index models also eliminates illogical or rather absurd results. The Single Index model (SIM) and the Capital Asset Pricing Model (CAPM) are such models used to calculate the optimum portfolio.

Using time series regression on the monthly returns we have estimated the beta coefficient for each stock. Using the market model of CAPM i.e., regressing each stock’s monthly returns against the market index (Nifty100) we have estimated individual stock beta’s.

By definition beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that calculates the expected return of an asset based on its beta and expected market returns (Investopedia, 2011). According to Wikipedia (2011), in finance, CAPM is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable

However, there are significant differences between smart beta and traditional capitalization-weighted investing. Rather than constructing the portfolio through the market capitalization weighted index, smart beta implicitly incorporate the expectation of the specific factors into the portfolio constructing process (Jacobs and Levy 2014) In another words, it is highly active in terms of factor selection. Therefore, smart beta investment is believed as an integration of passive investing and active investing (Towers Watson 2013).

Using the stock market to invest in securities can be risky but with a little research and a carefully thought out investment strategy the road to financial security can be successful. Portfolio selection is a critical step in the investment process when deciding on which securities and stocks to purchase. When investors are selecting securities for a portfolio, the risks and returns must be considered for each individual stock in addition to the risks and returns for the portfolio as a whole. When looking at stock risks, both beta and unsystematic risk should be taken into consideration. When high return stocks have a beta greater than one, this means these stocks are highly volatile in comparison to the overall market and prove to be more risky. Stocks with high unsystematic risk are likely to have changes in stock prices. It is recommended to continue diversifying the stock selection and the allocation of funds to avoid industry risks, or beta. Industry risks often affect all stocks in a given industry. It is also recommended to continually evaluate the company’s investment portfolio as market conditions and future trends can sometimes be unpredictable. In the event that the economy becomes unstable and the