Investing in Portfolios and CAPM Essay Example | Topics and Well Written Essays - 2000 words

Investing in Portfolios and CAPM - Essay ExampleIf the investor chooses alternative 1 and invests all the money in Evergreen, indeed he can agnise a return of 13.8%. Since Evergreen is a safe companionship, therefore the mensuration deviation of returns is quite low and risk coefficient is provided 0.11. One must sustainment in mind that by investing in this company, the investor is foregoing chance of earning high returns. In other words, the investor is foregoing chance of earning high returns for increased refuge by investing in this company. On the other hand, in the case of alternative 2, if the investor decides to invest in more dynamic of the two companies ACE limited, then the investor is foregoing safety of investment for high returns. This provide enable the investor to earn a return which is as high as 25%. However, the risk coefficient and standard deviation for this investment is also higher at 0.31 and 7.6% respectively. A third option is to invest in the form o f an equally weighted portfolio. In this case, the returns obligate increased from what the investor could earn by investing solely in Evergreen and at the kindred time the high risk of investing in iodin Ltd has also been reduced. The returns have increased from 13.8% to 19% and at the same time risk coefficient has decreased from 0.31 to 0.2. In the case of alternative 4, the investor will invest hard in Evergreen and take rattling small exposure in ACE. This option is probably the worst alternative because the returns of this option are not very high, but the risk has greatly increased to 0.47. In the above scenario, we can see that the returns have increased when the investor has decided to invest in portfolios and at the same time risk coefficient has gone down. This tells us that diversification leads to lower risk and high return. However, one must keep in mind that diversification only minimizes one type of risk that an investor faces. There is another kind of risk whi ch is known as systematic risk and it cannot be eliminated no matter how sanitary diversified the portfolio is. Hence, there is always some chance of investors losing money even if the money is invested in the form of a portfolio. The correlation coefficient above shows that the investment in Evergreen and Ace is negatively correlated. A shrewd investor always try to invest in companies that are negatively correlate so that the downward path in the returns of one business can be offset by the increased returns on the other investment in the same portfolio. However, since these two investments are not perfectly correlated, the portfolio is not well balance and some side will be higher than another and investor can face periods of high returns or loss depending on the market situation. It can be concluded from studying the above alternatives that it is wise for investors to not to take large exposures on one single stock. The investors should try to construct portfolios that should give equal or close weightage to all the companies in the portfolios in order to enjoy the benefits of risk diversification. If there is one company in the portfolio which has higher weightage than the other companies ten the portfolios performance will be highly dependent on that one company and benefits of diversification will disappear. TASK 2 Capital Asset Pricing Model is a tool to