ASSIGNMENT

On
Financial Management
Assignment No. 2
Submitted To:
Prof.Ayub Arshad
Submitted By:
Rana Janzhaib
Registration No.
M1F17BBAM0042

Program: BBA (HONS)

Semester: 5th

University Of Central Punjab

Q1: Describe procedures for assessing and measuring the
risk of a single asset.
The return of any investment has an average, which is also the expected return, but most returns will be
different from the average: some will be more, others will be less. The more individual returns deviate
from the expected return, the greater the risk and the greater the potential reward. The degree to which all
returns for a particular investment or asset deviate from the expected return of the investment is a
measure of its risk.

By Standard Deviation
Standard deviation measures the dispersion of data from its expected value. The standard deviation is
used in making an investment decision to measure the amount of historical volatility associated with an
investment relative to its annual rate of return. It indicates how much the current return is deviating from
its expected historical normal returns. For example, a stock that has high standard deviation experiences
higher volatility, and therefore, a higher level of risk is associated with the stock.

Standard Deviation Formula for Investment Returns

s = Standard Deviation
rk = Specific Return
rexpected = Expected Return
n = Number of Returns (sample size).

Coefficient of Variation •
The coefficient of variation, CV, is a measure of relative dispersion that is useful in comparing the risks
of assets with differing expected returns.

For example
if an investment had a 30 percent chance of returning 20 percent profits, a 50 percent chance of returning
10 percent profits and a 20 percent chance of returning 5 percent. Find the expected return.

Conditional Value at Risk (CVaR)

Generally speaking, if an investment has shown stability over time, then the value at risk may be
sufficient for risk management in a portfolio containing that investment. However, the less stable the
investment, the greater the chance that VaR will not give a full picture of the risks, as it is indifferent to
anything beyond its own threshold.
Conditional Value at Risk (CVaR) attempts to address the shortcomings of the VaR model, which is a
statistical technique used to measure the level of financial risk within a firm or an investment portfolio
over a specific time frame. While VaR represents a worst-case loss associated with a probability and a
time horizon, CVaR is the expected loss if that worst-case threshold is ever crossed. CVaR, in other
words, quantifies the expected losses that occur beyond the VaR breakpoint.

Coefficient of Variation: Measure of Relative Risk

The greater the standard deviation, the greater the risk of an investment. However, the standard
deviation cannot be used to compare investments unless they have the same expected return.

By Beta:

Beta is another commonplace degree of chance. Beta measures the amount of systematic risk an
person security or an business zone has relative to the whole inventory market. The marketplace
has a beta of 1, and it is able to be used to gauge the chance of a safety. If a safety’s beta is
identical to 1, the security’s charge actions in time step with the marketplace. A security with a
beta more than 1 suggests that it is more risky than the marketplace.

Conversely, if a safety’s beta is much less than 1, it suggests that the safety is less volatile than
the marketplace. For example, suppose a safety’s beta is 1.5. In theory, the safety is 50
percentages more volatile than the market.

Q No: 2
Review the two types of risk and the derivation and role of beta in measuring
the relevant risk of both an individual security and a portfolio. Also discuss
the sources of risk affecting financial manager.

1-Systematic Risk

Systematic risk is also called market risk or non-diversifiable risk as it is beyond the control of a
specific company or individual. Systematic risk is refers to the risk inherent to the entire market
or market segment. It affects the overall market and economy as a whole, not just a particular
stock or industry. This type of risk is both unpredictable and impossible to completely avoid. All
investments and securities suffer from such type of risk.
Example
The example of systematic risk is that, inflation and interest rate changes affect the entire market.
So, one can only avoid it by not investing in any risky assets.

Changes to government policies that affect all sectors is also the example of systematic risk.
Assume that government increases the minimum employee salary by 100%. You know employee
cost is a major spend for most of the companies. Such policy change will affect companies
across many sectors. Hence a major change in employee policy that will have a huge impact on
the economy.
2- Unsystematic Risk

Unsystematic risk can be described as the risks generated in a specific company or industry and
may not be applicable to other industries or economy as a whole. Unsystematic risk occur when
fluctuations in returns of company rising due to micro-economic factor. These risk factors exist
within a company and it can be avoided if necessary action is to be taken. Unsystematic risk is
also called as diversifiable risk.
Example

ABC Limited is an automobile manufacturing company in Pakistan. Due to a recent strike by the
workers of the particular region, the manufacturing plant is closed and the production activities
are stopped for a while. But the demand of the automobiles is the same and the overall economic
growth is intact. Thus, the above crisis can be sorted by means of conversation with the workers.
This is the good example of unsystematic risk.

What are the sources of risk affecting financial manager?

There are some sources of risk affecting the financial manager
1: Inflation Risk

With the rise in inflation, there is reduction of buying power, this is also referred to as buying
power risk and affects all securities. This risk is also directly related to interest rate risk, as
interest rates go up with inflation.
2: Market Risk

Market risk is refers to the variability of returns due to fluctuations in the securities market. All
securities are exposed to market risk but equity shares get the most affected. This risk includes a
wide range of factors exogenous to securities themselves like depressions, wars, politics, etc.
3: Liquidity Risk

This risk is associated with the secondary market in which the particular security is traded. A security
which can be bought or sold quickly without significant price concession is considered as liquid. The
greater the uncertainty about the time element and the price concession, the greater the liquidity risk.
Securities which have ready markets like treasury bills have lesser liquidity risk.

4: Business risk

This risk is refers to the risk of doing business in a particular industry or environment and it gets
transferred to the investors who invest in the business or company.
5: Financial risk

Financial risk arises when companies resort to financial leverage or the use of debt financing.
The more the company resorts to debt financing, the greater is the financial risk.
6: Exchange Rate Risk

Exchange rate risk is the possibility that the value of an investment will change when the
currency is exchanged. This occurs when there is movement in the exchange rate between
placing an order and the transaction being completed. Exchange rate risk is associated with all
foreign investments. This is the uncertainty that is inherent in dealing.

For example, a U.S. investor who buys a German stock denominated in marks must ultimately
convert the returns from this stock back to dollars. If the exchange rate has moved against the
investor, losses from these” exchange rate’ movements can partially or totally negate the original
return earned.
7: Interest rate risk

The variability in a security’s return resulting from changes in the level of interest rates is referred to
as interest rate risk. Such changes generally affect securities inversely; that is, other things being
equal, security prices move inversely to interest rates. Interest rate risk affects bonds more
directly than common stocks, but it affects both and is a very important consideration for most
investors.