StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...
Free

In Finance, Risk Is Best Judged in a Portfolio Context - Essay Example

Cite this document
Summary
The paper "In Finance, Risk Is Best Judged in a Portfolio Context" discusses that it is observed that MPT is not able to assess behavioral economics which means that investors may not act rationally in most of the situations where they have to make a decision regarding investing in stocks…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER93.5% of users find it useful
In Finance, Risk Is Best Judged in a Portfolio Context
Read Text Preview

Extract of sample "In Finance, Risk Is Best Judged in a Portfolio Context"

In finance, risk is best judged in a portfolio context." Is this true? Why? "In finance, riskis best judged in a portfolio context." Is this true? Why? Risk is uncertainty that investors face when making their investment decisions and they face a situation where not every risk can be diversified or mitigated. In other words, it can be said that risk is the uncertainty of returns on the amount that has been invested in the stocks. Therefore, they have to accept a certain level of risk in their investment portfolio where it is a set of assets and liability that an individual holds or is liable to. It is therefore, important to assess the aggregate risk in portfolio that can be faced by an individual. The aim of this paper is to critically assess the aspect of risk associated with investment and its judgment to be best in a portfolio context. This paper takes an argument to prove that individual stock cannot allow investors to help judging the overall risk associated with investment on shares. A critical criticism context will also be introduced in the paper later on to justify the argument regarding risk being judged better in a portfolio of stocks. It will not be incorrect to state that investors of stock market are directly associated with the risk which is not avoidable. These risks can be variable in types such as short-term risk or portfolio risk. For the focus of this paper, portfolio risk is being discussed in a contextual manner. It should be noted that portfolio risk is relatively low in accordance to the movements within the stock market. Herein, the process or concept of aggregation is considered for calculating risk associated with an asset or for valuing a company. It is due to this reason that individual investors are suggested to manage their portfolio risk because their individual transactions are aggregated. This denotes that investors tend to diversify their assets in order to judge the risk of security (Brealey, et al., 2010). It is not being proven here that by taking an aggregate of the risk of in a portfolio can eliminate risk. Portfolio of stock allows the investors to understand the associated risk in accordance of variation in all levels of the market. There is an underlying condition associated with portfolio risk. As a matter of fact, risk can be best judged in a portfolio context, as diversified stocks can have reduced risk. The underlying condition is that the return which is received by the investors is less than one. In this case, it is stated that diversification will remain beneficial or the investors (Brealey, et al., 2010). Risk or systematic risk is interlinked with the changes that may occur in the market. The risk is applicable on all the individuals associated with the portfolio of stocks. There can be some of the factors that would influence the portfolio risk such as global downturn, national economic chaos etc. Therefore, it can be said that the investment value of any stock can decrease readily when there are a number of differential measures of risk. Consequently, investors would like to diversify their stocks in such a way that they are moved together within a market to ensure that they can easily response to the market crisis. Economic analysts have maintained the idea that standard deviation of a portfolio which has been diversified greatly in an effective manner will always remain proportional to its risk measure (Brealey, et al., 2010). It is the need of risk management that different models and approaches have been framed for investors. Economic analyst have experimented with different formulas and calculations that provides ways of investing in a stock which will be high on his return value and lower in terms of risk. As a matter of fact, such an ideal situation is complex to find out. Among these approaches, Modern Portfolio Theory is best for investors to manage their portfolio risk. The approach was derived from the basis of risk modeling by Harry Markowitz. In order to diversify the portfolio risk, Harry came up with certain approaches (Brealey, et al., 2010). As mentioned in the above discussion and the statement of MPT theory, it becomes evident to note that investors must assess the risk and return but not on an individual level. By making sure that the investment has been done on various stocks, it can easily be noted that the diversification can be achieved. This approach has been states as not putting all of your eggs in one basket in the field of finance. In order to understand the implication of the theory, let us take an example where an investor values a stock or invest on a stock during a rainy day while other investor invests on a day when it did not rain. In a collective manner, both the stocks will pay off by covering the risk associated with one stock by the other one which does not have the risk associated with it (Brealey, et al., 2010). Thus, it is suggested that the investors are able to invest in stocks in an aggregated manner. One should not look for the stocks that are individual but those that are in collective portfolio. It is due to this reason that investors have now been able to look at the stocks that are diversified in nature. MPT in particular had a great impact on the investors in perceiving the risk associated with investment in stocks. Many organizations in the current business setting are making use of the theory in a continuous manner (Brealey, et al., 2010). Along with the aligned benefits and theoretical grounds of MPT, number critics have claimed that there are some of the shortcomings of MPT that cannot be avoided at any cost. Some of the critics claim that the situation that is presented by the theory of MPT does not align with the real world setting. In simpler words, it can be well stated that the assumption on which the theory has been presented is not close to practicality. As per the investigation in this context, it has been observed that there are issues of instabilities that may occur on the penalty term. Also, there are large swings in the measure of standard deviation among different stocks. The distribution of the risk from each stock will never be same when it comes to real world practice because of the mean-variance (Brealey, et al., 2010). Another aspect which has been raised as a concern by the critics regarding MPT is that the correlation between different assets would remain fixed. Along with its constant values, thee assets are more likely to be distributed on a random basis. This notes that correlation between the stock values will be dependent upon the assets. In a condition where there is an economic downturn is observed in a country, it is expected that all the assets would go down together. Therefore, their correlation is more likely to become positive in nature. In such condition, MPT does not react to the situation making the investors vulnerable to get protection from the risk noted on the whole board (Brealey, et al., 2010). In addition, it is observed that MPT is not able to assess the behavioral economics which means that investors may not act rational in most of the situation where they have to take a decision regarding investing in stocks. There is no way in which MPT ensures that informed knowledge of the stock value may help investors. Other than that MPT has another shortcoming of spreading the idea that by selecting the stock portfolio, anyone can save themselves from the unrated value of stocks and risk associated with it. It should be noted that stock market is a pool where different investors come to make sure that they can invest in stocks that are higher in return. This means that investing by following MPT may not be fruitful for everyone to gain higher value ends and secured returns because of overall or aggregated risk (Brealey, et al., 2010). In order to draw a line to prove that risk can be best judged in a context portfolio, it can be well stated that the elements and factors that are variable in nature will produce higher statistics of risk on an individual stock level. This is a generally accepted belief of finance. Be it CAPM or MPT, any theory of model can be used to differentiate between the advantages of portfolio context and individual stock to determine the risk (Brealey, et al., 2010). Through the above analysis and arguments, it comes to understanding that risk is unavoidable. Investors may will for investing in stocks that are higher in terms of return and with lower risk rate associated with them. However, the situation is too good to be true therefore, it is suggested that investors are looking for stocks that are present in a collective or portfolio manner. In this way, it is expected that the risk associated with the stocks will be less and cover individual stock risk with the help of another stock. Thus, finally it can be stated that the best way to judge risk is in the context of portfolio. References Brealey, R., Myers, S. & Allen, F., 2010. Principles of Corporate Finance, Latest edition, McGraw-Hill International.. Latest ed. New York: McGraw-Hill International. Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(“In finance, risk is best judged in a portfolio context. Is this true Essay - 7”, n.d.)
Retrieved from https://studentshare.org/finance-accounting/1637312-in-finance-risk-is-best-judged-in-a-portfolio-context-is-this-true-why
(In Finance, Risk Is Best Judged in a Portfolio Context. Is This True Essay - 7)
https://studentshare.org/finance-accounting/1637312-in-finance-risk-is-best-judged-in-a-portfolio-context-is-this-true-why.
“In Finance, Risk Is Best Judged in a Portfolio Context. Is This True Essay - 7”, n.d. https://studentshare.org/finance-accounting/1637312-in-finance-risk-is-best-judged-in-a-portfolio-context-is-this-true-why.
  • Cited: 0 times

CHECK THESE SAMPLES OF In Finance, Risk Is Best Judged in a Portfolio Context

Funding Healthcare System

Funding Healthcare System, Sharing Risk and portfolio Theory Name Institution Date Funding Healthcare System, Sharing Risk and portfolio Theory Introduction Health care systems should ever remain reliable and sustainable.... Sustainable healthcare systems are often reliable to capital, human, and consumable resources....
17 Pages (4250 words) Thesis

Finance Risk in a Portfolio Context

In the paper 'Finance risk in a portfolio context' the author analyzes the term portfolio which can be defined as a collection of investments that are held by an individual or by a company.... To correctly judge the risk in a certain area it is important to judge from a portfolio.... The objective of this theory is to maximize the expected return of a portfolio for a certain level of portfolio risk.... The objective of this theory is to maximize the expected return of a portfolio for a certain level of portfolio risk....
6 Pages (1500 words) Admission/Application Essay

Whether in Finance, the Risk Is Best Judged in a Portfolio Context

From the paper "Whether in Finance, the risk is best judged in a portfolio context?... After discussing these aspects the researcher will summarise the whole topic and find out risk is the best judge in the portfolio context or not.... isk and Return In the terms of Investment, the risk is the probability of difference between the expected returns and the actual return of investment.... The risk is calculated through the standard deviation of the average or historical return of the particular investment....
7 Pages (1750 words) Essay

Risk and Portfolio Context

risk is a core element of investment and is inseparable from investment function.... ), in investment risk is the possibility of monetary loss through the loss in value of the investment instrument.... risk is a subjective measure with many possible definitions.... Therefore, the subjectivity of the risk is its only main characteristic.... This kind of risk is beyond the control of the investor.... Types of Systematic Risks Interest rate risk is the risk that due to change in interest rate over time will result in value of security going down (FINRA, 2013)....
6 Pages (1500 words) Essay

In finance, risk is best judged in a portfolio context. Is this true Why

“In finance, risk is best judged in a portfolio context.... portfolio Theory The fundamental of the portfolio theory indicates to diversify different types of securities in to different types of risk for the purpose to minimise the risk factor.... Since, the foreign exchange market operates 24 hours in a day, investing in different markets will ensure maximum returns to the portfolio by taking the advantage of the variance in the currency value in different markets....
5 Pages (1250 words) Essay

Risk Is Best Judged in a Portfolio Context

“In finance, risk is best judged in a portfolio context.... Is this true?... Why?...
6 Pages (1500 words) Essay

Risk in Financial Context

It is worth noting that risks and In this context, the greater the risk, the more that alternative is unfavourable while if the risk is lower the alternative is the best for an individual to take a course of action into it (ALEXANDER, 2008).... The actual meaning of the word ‘risk' is difficult to explain despite the different definitions by different scholars as in their definition risk meant different things in their situation.... Due to different understanding of term risk many scholars are of other takes that measure risks especially those that emphasizes on negative results or that are below some known referent points....
7 Pages (1750 words) Essay

Portfolio Theory and the Capital Asset Pricing Model

The paper "portfolio Theory and the Capital Asset Pricing Model" states that the financial markets have developed to such a degree and complexity, linking with markets across the globe, that the risks of investing one's hard-earned money require a reliable method.... Together, the two types of decisions are known as the consumption-saving decision and the portfolio selection decision.... Of the portfolio selection process, two of the most fundamental and often-used theories that have been developed are the portfolio theory and the capital asset pricing model (CAPM)....
11 Pages (2750 words) Coursework
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us