Risk and return analysis report for the Stock Market Index and the two companies, the Bank West and the Clip Industries
The mean (expected) returns of the market index and the two companies, Bank West and Clip Industries stocks’ are computed as 3.84%, 7.65% and 0.88% respectively. An expected return is the average measure or the amount of loss or profit an investor expects on an investment on the basis of several expected or known rates of return over a certain period (Murphy, 1994; Investopedia.com, 2012). In other words, it can be interpreted as the average monthly return value (+ve for profits, -ve for losses) a stock or an index has obtained overall during the given time period. As observed, the expected return is highest for Bank West, and lowest for Clip Industries.
The standard deviation (SD) is the measure of risk or the volatility in the monthly returns of a stock to its expected value (Graham and Zweig, 2013). The SDs of the market index and the two companies, Bank West and Clip Industries stocks’ are computed as 3.403%, 8.097%, and 8.667%. A higher value of SD for a stock’s monthly return implies a higher amount of risk involved with the investment in that stock, i.e. the returns are inconclusive and can be unusually higher or lower. Therefore, it can be said that a risk-averse investor may prefer to invest in the market index portfolio, rather than making investments solely in either of the two aforesaid companies due a lower risk involved, while a risk-seeking investor will invest in the Clip Industries or the Bank West (in preference) which sure has higher risk involved but, may provide the investor higher expected returns.
The coefficient of variation (COV) is a measure of spread that describes the amount of variability relative to the mean (Damodaran, 2007). The COV of the market index and the two companies, Bank West and Clip Industries stocks’ are computed as 0.886, 1.058 and 9.821 respectively. It can be observed from the above values that the Clip Industries’ monthly returns are varied over a large range and demonstrate a very high variability.
The correlation coefficient between the Bank West and the Clip Industries is –0.0983, which implies a poor negative relationship between the monthly returns of these two industries, i.e. an increase in the monthly return of one stock will result in a decrease in the monthly return of another stock and vice-versa; however, the dependence is very poor.
For the portfolio obtained for the two equally weighted industries, the expected return was computed as 4.27% and the standard deviation as 5.6318%. For the purpose of risk minimization, a portfolio with the lowest investment risk involved was formulated with average weightings of Bank West and Clip Industries as 0.5309 and 0.4691 (or 53.09% and 46.91%) respectively. This resulted in the lowest standard deviation of 5.6187% possible for a portfolio of these two companies.
Beta is a function of the volatility of the asset and the market and reflects suggests how risky an asset is compared to overall market risk. In other words, it is a correlation coefficient between the market and the specified stock and represents the tendency of the stock’s returns to respond to swings in the market (Graham and Zweig, 2013). For the Bank West and the Clip Industries, betas were computed as 1.3147 and –0.5570 respectively, suggesting that the Bank West stock's monthly returns are theoretically more volatile than the market and provides the chance of a higher expected return, but at the same time, posing higher risk. However, for the Clip Industries, a negative beta demonstrates that the expected returns may outperform the benchmark by 55.7% during down markets and underperform by 55.7% in up markets.
Murphy, J.E. (1994) Stock market probability: Using statistics to predict and optimize investment outcomes. Chicago, IL: Irwin Professional Publishing.
Damodaran, A. (2007) Strategic risk taking: A framework for risk management. 2nd edn. United States: Pearson Prentice Hall.
Investopedia.com (2012) ‘Expected return, variance and standard deviation of A portfolio’, in Available at: https://www.investopedia.com/walkthrough/corporate-finance/4/return-risk/expected-return.aspx (Accessed: 12 September 2016).
Graham, B. and Zweig, J. (2013) The intelligent investor: A book of practical counsel. New York: HarperBusiness Essentials.
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