Risk and Return Analysis Inception and Retract Ltd

Question: Discuss about theRisk and Return Analysisfor Inception and Retract Ltd. Answer: An investor undertakes risk to maximize his returns. Risk is measured by the standard deviation of returns of the stock and returns are the average returns over a period of time. An investor normally invests in more than one stock to diversify his portfolio in order to minimize his risk and maximize his returns. However, the choice of stocks in the portfolio depends on the stocks returns, their individual risk and correlations between the stocks in the portfolio (McGraw-Hill, NA) In the present scenario, stocks of two companies Inception and Retract Ltd. have been considered and both the stocks have been analysed with respect to the market and to each other to see their combination in a portfolio. The table presenting the statistical measures of the stocks is given below: Market index Inception Retract Ltd Expected Returns 1.40% 5.24% 2.85% Standard deviation 5.44% 16.84% 18.91% Coefficient of variation 3.89 3.21 6.64 Correlation coefficient -0.02 Portfolio standard deviation 1.57% Beta 1.55 1.76 The expected returns for Inception are the highest; even Retract Ltd. has returns more than the market. This makes both the stocks worth the investment as they are giving on an average high returns. The stocks of Retract Ltd. are more risky as it has a higher standard deviation as compared to Inception. This has increased the coefficient of variation for the stocks of Retract as it has higher risk and comparatively lower return. This means Retract stocks have higher degree of volatility as compared to Inception. In fact, the degree of volatility of Inception is lower than that of the market making it an attractive investment. Correlation coefficient measures the movement of two stocks i.e. whether they move in the same directions or opposite directions. It ranges from -1 to 1 (Russell, 2014) The above stocks have a negative correlation at -0.02 which means that when the price of one stock rises, the price of other stock will fall but the correlation is very weak and hence it can be said that the stocks are not much related. The portfolio standard deviation is quite low at 1.57% as compared to individual deviations. This is because negatively correlated stocks diversify the portfolio. If returns from one stock decreases, the returns from another will increase, thus not affecting the returns much. Lower the portfolio standard deviation, lower is the risk. Beta is the risk of the stock in relation to the market. Beta more than 1 means the stock is more responsive to the market risk. Retract Ltd. is more volatile as it has a higher beta of 1.76 which means that stocks of Retract are 76% more volatile than the market. Beta is a systematic risk and cannot be eliminated; hence, an investor should try to minimize his risk by diversifying his portfolio. In the above scenario, both stocks have a beta of more than 1, even though they are negatively correlated but the degree of correlation is very weak, hence, this will not help in diversifying the portfolio because a fall in the market returns will result in both stock returns falling with a higher percentage. Reference Russell, R., (2014), ABCs of Investing: Alpha, Beta and Correlation, accessed online on 29th April, 2017, available at https://www.forbes.com/sites/robrussell/2014/07/15/abcs-of-investing-for-experienced-investors/#501a1e72393f Zkjadoon, (2016), Risk and Return Analysis in Financial Management, accessed online on 29th April, 2017, available at, https://www.businessstudynotes.com/finance/financial-management/risk-and-return-analysis-financial-management/ McGraw-Hill, (NA), Risk and Return, McGraw Hill Australia