Economics

For this case study, you will create a portfolio of five to eight stocks that demonstrate diversified risk. List the stocks along with their current price and previous 1-year and 5-year rates of return. Below the list of stocks, address the issues described below.
Explain the difference between portfolio risk and stand-alone risk.
Briefly explain why you selected each stock and how this investment portfolio would have less risk than selecting just one stock.
How does risk aversion affect a stock’s required rate of return?
Explain the distinction between a stock’s price and its intrinsic value.
Your case study should be at least two pages in length, not counting the title and reference pages. You are required to cite and reference at least your textbook and stock data source. Use APA format to cite in-text and reference citations

ANSWER

Stock diversification is vital in reducing risk and promoting a better return on investment. To create a diversified portfolio, I am going to create a portfolio of six stocks. The first one is U.S stocks that are based on public corporations also abbreviated as the S&P 500. The 5-year average of the U.S stock is 40.85 while the last value documented in February 2021 stands at 97.24% with an average growth rate of 40.57%. The second stock is the U.S Fixed Income that comprises bonds, certificate of deposits and money market funds. The 5-year treasury rate according to Y charts is 0.85% and a 1-year rate of 0.08%. The third stock on the portfolio is foreign stocks that comprise companies in emerging markets and overseas. The return on this type of stock highly depends on the country and is easily affected by a change in the political climate of the country.  For example, the I year rates for Canada is 6.25%, Europe 4.00% and Australia 6.25% to name a few. The fourth alternative is a foreign fixed income that includes both government and corporate issues. The foreign fixed income is safer than foreign stock but also differs from country to country. Other forms of investment include a variety of assets such as real estate, hedge funds and cryptocurrencies. Minerals too are a form of a diversified portfolio included in this investment plan which offers security against stock market crash and inflations. Similarly, gold is uncorrelated to assets like bonds and stock.

The difference between portfolio risk and stand-alone risk is that portfolio risk takes into account that a combination of assets within the investments do not meet objectives financially. The biggest difference in comparison to standalone risk that portfolio risk considers all investments and their assessment in order to calculate risk while on the other hand, standalone risk only takes into account the asset that is being assessed as the only investment that an investor could lose or gain.

Considering the six types of stocks given above would have less risk than selecting just one stock. As already demonstrated, the US stock has the highest risk but also the highest gain, however, the US Fixed Income has a small margin of loss and profit which is also equivalent to Foreign Stock and Foreign Fixed Income. Assets Investment such as real estate is slower in terms of return but depending on the assets, the gradual return is also equally more secure. However, to really achieve security against market phenomena such as inflation, minerals such as gold becomes the best alternative. Combined together, the investment portfolio and potential become greater and a bigger benefit to the investor.

Risk aversion affects the rate of return in that in a market where risk-averse investors dominate the market, securities with more risk have high expected returns. These conditions must stand lest the normal buying and selling push the condition to stand. An increase in aversion proportionally increases money holding on the general economy. The more the risk aversion increases, the more the demand for money will cause huge impacts on the economy of a country (O’Donoghue 2018).

The distinction between a stock’s price and its intrinsic value is that the stock price is generally the market price and can be simply observed in public traded companies. However, the intrinsic value can only be estimated and cannot be directly observed (Rawley 2021).

References

O’Donoghue, T., & Somerville, J. (2018). Modelling risk aversion in economics. Journal of Economic Perspectives, 32(2), 91-114.

Rawley, T., & Gup, B. E. (2021). The valuation handbook: valuation techniques from today’s top practitioners.