Maximisation of wealth implies increasing the value of the basket of goods, commodities or shares held by the investor. In markets, it generally implies the increase in the value of the company such that the value of the share or its market price is increased. Whereas, maximisation of profit is a concept where profits earned by the company over a period is maximised. The ultimate goal here is that the all the operating, investment and financing decisions are aimed at maximisation of the profit of the shareholders. The concept of profit maximisation is short term and that of wealth maximisation is a long-term concept. (Grenier, 2017)
Suppose for example, the earning per share of the firm is $ 4, book value per share increases by $ 20 over a period but the market value decreases by $ 12, i.e., the share prices fall by $ 12, then in this case, the share would be outrighly rejected as it is destroying the shareholders wealth. The end objective of any investor in the market is to increase the market value of the share.
The other variable, which differ in case of these two concepts, is profit maximisation does not takes into consideration risks and uncertainty whereas wealth maximisation does takes care of it. Profit just acts a reward for the operational efficiency of the firm whereas wealth maximisation focuses on gaining a larger market share. (Mahapatra, Levental, & Narasimhan, 2017)
From the above examples and explanation, it is clear that the undisputed objective of financial management is to increase the value of market capitalization of the company and hence the shareholders wealth. (Meroño-Cerdán, Lopez-Nicolas, & Molina-Castillo, 2017)
Risk aversion is nature of the investor based on what and how much amount of risk the investor has the capacity to bear and is ready to take. It does not necessarily mean manager of the corporate will only invest in the non-risk free investments. It perfectly depends on the risk appetite and may vary person to person and situation situation. The more the risk, the higher the returns and the less the risk, the lesser are the returns. (Wang, Cai, Tsay, & Vakharia, 2017) The one with risk aversion will generally opt for the the securities with the sure returns percentage and will invest in the debts or fixed deposits whereas the one with the no risk aversion will opt for securities which may give higher returns. Many risk averse individuals make their final selections by putting weightage on what could be the worst possible outcome in the given circumstance and in the given investment. (Heminway, 2017)
Suppose there are 2 securities, one that has small ageing of 6 months and it may fetch or yield 20% half yearly or may give 5% too. The other option is a security, which again will be there for 6 months and will give a return of 8% half yearly for sure, whatever may be the circumstances. The person with risk aversion will always go for the second security, as he/she would be expecting and happy with the fixed return of 8% rather than taking risk and may be losing out at 5%. Thus, the statement given in the question is completed in disagreement with the reality. Risk aversion generally comes into picture in case of an option to choose amongst the decision to invest or not, or when there are multiple securities to choose from. (Jefferson, 2017)
Based on the results that we see for both the CBA and RIO from both the CAPM and SML perspective, I would be investing in CBA rather than in Rio because of the following 2 reasons:
The return on CBA is 7.41%, which is higher than RIO’s expected return using CAPM by 0.6%, though the risk is a bit high, the returns in lieu of it would be more. (Murray & Markey?Towler, 2017)
The second reason for investing CBA is the standard deviation, which is a meagre 5.74% as compared to 8.93% for RIO. This shows that there may be fluctuation in returns given by RIO to the extent of approximately 9% as compared to the calculated expected returns per CAPM. (Macmillan, 2016)
For taking this decision, the past returns and the average holding return during the last one year as calculated above has not been taken into consideration.
Grenier, J. (2017). Encouraging Professional Skepticism in the Industry Specialization Era. Journal of Business Ethics, 142(2), 241-256.
Heminway, J. (2017). Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents. SSRN, 1-35.
Jefferson, M. (2017). Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland . Technological Forecasting and Social Change, 353-354.
Macmillan, P. (2016). Thomas Klikauer: Hegel’s Moral Corporation. Journal of Business Ethics, 302.
Mahapatra, S., Levental, S., & Narasimhan, R. (2017). Market price uncertainty, risk aversion and procurement: Combining contracts and open market sourcing alternatives. International Journal of Production Economics, 34-51.
Meroño-Cerdán, A., Lopez-Nicolas, C., & Molina-Castillo, F. (2017). Risk aversion, innovation and performance in family firms. Economics of Innovation and new technology, 1-15.
Murray, C., & Markey?Towler, B. (2017). A Theory of Return-Seeking Firms. SSRN, 1-14.
Wang, L., Cai, G., Tsay, A., & Vakharia, A. (2017). Design of the Reverse Channel for Remanufacturing: Must Profit-Maximization Harm the Environment? Production and Operations Management, 1585-1603.