Essay Example on 2 Beta and Non systematic Risk









The risk of a portfolio consists of systematic risk beta and non systematic risk Beta measures the volatility or systematic risk of an asset or a portfolio relative to the benchmark as a whole It is generated by regressing the return of individual security or the portfolio on the return of NZX50 The returns are 3 year monthly returns for each security and NZX50 Table 2 below shows the comparison between stock or portfolio beta and the benchmark beta Since the benchmark beta is 1 a beta greater than 1 indicates the market risk of the portfolio is bigger and vice versa The portfolio beta is 1 18 meaning it is more volatile than NZX50 As Keith is identified to have an above average risk tolerance so the portfolio is expected to be more risky than the market index in order to achieve a high excess return Unsystematic risk is associated with factors related to a particular firm It can be diversified as the number of securities increases in a portfolio 

As can be seen in Table 2 the non systematic risk has been reduced as a result of holding the four stocks with only 6 67 This implies that the diversification of the portfolio is efficient The low non systematic risk of the portfolio helps reduce overall investment risks and avoid poor performance caused by the uncertainty inherent in a firm or an industry Table 2 Based on the average return standard deviation beta and non systematic risk the portfolio performance can be further evaluated by different ratios in order to present an overall measurement of the investment 3 Sharpe's Measure Sharpe ratio measures the excess return relative to total risk standard deviation A higher asset s Sharpe ratio implies that it has better risk adjusted performance The Sharpe ratio is appropriate for the assets with large amounts of unsystematic risk Table 3 demonstrates the ranking by Sharpe ratio for the four securities NZX50 and a managed portfolio which consists of the four securities All the Sharpe ratios are negative value in the Table 3 which means the T bill bond performed better than these securities during the holding period However as the stock market has been underperforming during the observation period this whole market downturn might be due to a seasonality reason The Sharpe ratio for the NZX50 has the lowest value which indicates that we still outperformed NZX50 on a risk adjusted basis Table 3 4 Treynor's Measure Treynor ratio is used to represent the relationship between the excess return over the risk free rate and systematic risk beta The greater value of the Treynor ratio the higher return on each of the market risks Generally this measurement is useful for the completely diversified portfolios 

As shown in Table 4 similar to in Sharpe's measure all the values are negative Obviously the Treynor ratio of our portfolio is slightly higher than the value of NZX50 Again it implies that the managed portfolio performed better than market index regardless of a risk adjusted basis Table 4 s 5 Jensen's Measure Jensen s Alpha is based on capital asset pricing model CAPM it measures the return on actual security or portfolio in relation to the expected market return The positive value of Jensen's Alpha it indicates that excess returns of the security or portfolio are compensated for the risk Based on Table 5 Jensen s Alpha shows that the managed portfolio earned an excess return which is 0 32 higher than the return implied by the Security Market Line SML reflecting the managed portfolio outperformed NZX50 However Jensen s Alpha is not appropriate to compare fully diversified portfolios with different betas and therefore we have looked into more measurements Table 5 6 Appraisal Ratio The Appraisal ratio is also known as the information ratio it is used to measure how the alpha relates to the unsystematic risk in the other word it reflects the ability of a fund manager to pick the security or portfolio that differs from that of the benchmark The higher the Appraisal Ratio refers to the fund manager has better performance to generate a portfolio From Table 6 the Appraisal ratio of the managed portfolio is the highest than the four securities and the benchmark MCY and MFT both have negative value 0 0275 and 0 0775 however RBD and FPH have positive value which are 0 0421 and 0 0403 respectively

 All in all based on the Appraisal ratio the managed portfolio outperformed NZX50 Table 6 7 M2 Measure and T2 Measure The M2 measure is also called the Modigliani risk adjusted performance measure it measures the risk adjusted return of portfolio It is similar to the Sharpe ratio but M2 has an advantage in units of percentage return which is easier to interpret in case of negative returns 

The greater M2 ratio the better performance of portfolio Table 7 below shows the ratio of four securities are greater than the portfolio while the ratio of portfolio is greater than market index T2 measure is derive from the Treynor measure it measures the differential between the return on the adjusted portfolio and the return on the market portfolio which the rationale is the same as the M2 As shown in Table 7 since the ratio of our portfolio is greater than benchmark the managed portfolio outperformed NZX50 Table 7 Generally speaking all above risk adjusted performance methods show that the portfolio has higher values compare with benchmark According to the above evidences we consider the managed portfolio outperformed the market index during 11 Dec 2017 and 19 Jan 2018

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