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Financial Risk Modeling and Analytical Methods Essay


Comment on relative frustration of the two variables

XOM (Mobil-Exxon) is an individual share, while MRT (Market Portfolio) is an aggregate market value of all shares named. The market portfolio has a reflection of the market reaction within the financial period depicted. The difference between the two variables is that one has a reflection of other shares in that portfolio, while the other one is an individual share. It is noted that the two variables fluctuate in the same direction in most cases hence meaning that XOM has a big impact on the aggregate market fluctuation.

The only difference between the two sides is that market liquidity is different (Altwies, 2010.P. 23). The two moves in a different distance, reflecting disparities in the two variables liquidity. If a shared variable is liquid than the other, this means that it will fluctuate more than the other. This is irrespective of the direction. On the same note, Xom has more negative reflection as compared to the market portfolio.

This is because the market portfolio is an average of all share variables in the market hence providing a pool of risk. In most cases, the market portfolio is availed to reflect the whole market performance, but individual share aggregation reflects the market position of that particular share in a specified financial period. The above case, therefore, shows that the share market during the specified period was stable mainly because it is more represented above zero (Sanghera, 2011.P. 91).

Refer to the Excel page provided separately for the calculation

The contrast of the risk premium of the two variables

Microsoft’s share seems to be more volatile than the market portfolio. The higher the volatility of the stock, the higher the risk to the investor since the share is unstable. This same principle applies whereby the higher the volatility of the share, the higher the expected profit. If the investor decides to invest all his or her money in Microsoft alone, it means that there is a higher possibility that he or she can make a big profit or make a huge loss.

Share volatility indicates the shared liquidity without the respect of the market direction. The share price might take any direction hence proving to be risky. From the available data of the Microsoft share, it can be seen that this stock moves to the two extremes i.e. negative and positive. There is no certainty on the share direction hence increasing investors’ risk and investment on this single share implies that the investor might be using speculation (Jagannathan, 2002.P.12).

Contrary to this notion, the market portfolio provides a reduced risk and profit platform but a definite platform. The market volatility can be considered low holding the fact that it offers a pool of risk by forming a good risk spread portfolio, which accommodates all shares in the market. Investor certainty is a plus and this portfolio is made of speculation free situation holding the fact that not all shares move in the same direction.

Investors stand not to lose all his or her investment in case one of the shares proves otherwise. On the other hand, if the investor puts all his money in Microsoft and the markets move to his advantage, it means that he stands to benefit more than the investor who was a risk-averse and formed a portfolio (Jagannathan, 2002.P. 43). Contrary to this notion, if the market proves otherwise, then the investor with a portfolio will continue to enjoy a steady income from the investment, compared to the investor with a single share investment.

With the current economic performance in the world market platform, the share market of international companies like Microsoft is not stable and there is a high possibility that the company share value will change consistently in a different direction. This reduces the certainty of the investor and the decision to invest is based on speculation. To reduce the risk while investing, investors are advised to form a market portfolio of different shares from different industries, since not all industries are affected by the same market factors. In the case of inflation, financial industry shares are more exposed than technological shares like those of Microsoft.

Holding the fact that investors have a risk concept at mind when undertaking any investment, it is therefore advisable to manipulate the risk percentage by having many shares at once. An investor should spread the capital they have to various shares to form a portfolio. This will not only improve certainty in their investment but might also affect the investor profitability due to the reduced market share volatility concept (Siegel, 2008.P.14).

Descriptive Statistics of GE, GM, IBM, DIS Data

General Electric company share for the period has a positive average share price of 0.002842. This, therefore, means that the company’s investors had a positive gain at the end of the specified investment period. On the same note, the share price frustrated within the rage (zero) hence making it less volatile and more certain to the investors. Holding the fact that the company deals with electricity services, the demand for its services is constant and therefore retaining a constant price fluctuation in the market (Jagannathan, 2002.P.23). The company share prices are determined by company activities. If the activities that generate profits remain constant, then the company share volatility will remain constant or within a range.

General Motors have a negative average share price within the specified economic period (-0.00908). This implies that the share price operated below the equilibrium. Investors could have made a loss in the investment made. This was attributed to the international market fluctuation within the economic period specified. The general motors market was affected by inflation and deflation hence reducing the rate of consumption of the goods and services offered by the company. This reduced the company profitability hence creating a negative impact on the company share price. A company share reflects the company operations and in this case, the company operated with a deficit, hence no share price growth.

IBM had an average share price of 0.008332. This shows that the company operated on profit. This growth was within the range because there was little fluctuation recorded within the given time flame. The company operations were less affected by the international economic situation, hence supporting a stable share price all through. Mobile – Exxon had stable fluctuations in the market and it recorded an average range of 0.000148 throughout the economic period (Mulcahy, 2005. P.36).

The central tendency and valiance recorded by the stocks of the above companies reflect the company financial performance. It is noted that most of these companies operate in the international platform and the global economic performance can be reflected by their performance. From the year 2007, the world economic performance was interrupted by inflation and later deflation. This was reflected by the individual share of the above companies.

Electricity is a basic commodity and its demand remained constant, hence making the company stable. Central tendency refers to the possibility of the share price to revolve around the zero range. Most of these shares operate in this range hence obeying the central tendency theory.

Refer to the Excel page provided separately for the calculation

The two stocks are aggressive and this reflects two possible risks. First, there is a possibility to make more in investing in either share and there is also a possibility of making a loss. The general motor is more aggressive than Microsoft. This means that the share price of general motors is more liquid than that of Microsoft (Phillips 2007. P. 41)

CAPM Microsoft

No. This is because of the fluctuating risk factors. Zero means that the share operates at the equilibrium. This negates the investor’s intention. Investors are motivated by the profit ratio expected from their investment and if the motivating factor is zero, then there is no need to invest in risky ventures. Most investors are risk-takers and they feel free to take up risks for possible gains.

Refer to the Excel page provided separately for the calculation

A beta of less than one reduces the share aggressiveness. The lesser the beta, the less aggressive is the share. This de-motivates the investors holding the fact that there is less risk expected, as well as a little profit expectation. A stock with a high beta has the capacity of being volatile, hence promises high returns on the stock. The same stock de-motivates investors which are risk-averse. These investors don’t like a high-risk presence a factor that is provided by a high beta rate.

Risk Premium

A risk premium of the market portfolio reflects an aggregate premium of all shares in the market by which the investor has formed a portfolio. In this case, a market premium of 2% means that Microsoft premium stands between 2 + or -1 (Satchell, 2007. P. 16). A market premium of 7% means that Microsoft stands to be within the same rage of 7% + or – 1. This gives the meaning of market premium which is generated by aggregating the share stocks in a portfolio. Holding the fact that premium is an average, it then implies that there is a possibility that the individual stock is within the range (Fabozzi, 2006.p. 91).

All factors held constant, the same can go beyond + or – 1 rate mainly because the premium is an average rate of various stocks. Microsoft could go beyond + or – 3 but the limit must be within the range. While aggregating, it is assumed that all stocks performed equally but the reality is that some stocks might fluctuate more than the others. It depends on the market performance of that particular stock and the economic condition of the whole economy.

Some factors affect all the stocks equally hence forcing them to behave equally. On the other way, some stock might be affected individually hence affecting the stock premium. In this case, some unrealistic values are arrived at hence making it difficult to predict a single stock premium with the help of the portfolio premium (Fabozzi, 2006.p. 91).


Altwies, D & Reynolds, F 2010, Achieve CAPM exam success a concise study guide and desk reference, Ross Pub, Ft. Lauderdale.

Fabozzi, FJ & Focardi, S M & Kolm, PN 2006, Financial modeling of the equity market: from CAPM to cointegration, Wiley and Sons, Hoboken, N.J.

Jagannathan, R & Meier, I 2002, Do we need CAPM for capital budgeting? National Bureau of Economic Research, Cambridge, MA.

Mulcahy, R 2005, Hot topics: flashcards for passing the PMP and CAPM exams (5th ed.), RMC Project Management, Philadelphia.

Phillips, J 2007, CAPM, McGraw-Hill, New York.

Sanghera, P 2011, CAPM in-depth Certified Associate in Project Management study guide for the CAPM exam, Course Technology PTR/Cengage Learning, Boston.

Satchell, S 2007, Forecasting expected returns in the financial markets, Academic Press, Amsterdam.

Siegel, J.J 2008, Stocks for the long run: the definitive guide to financial market returns and long-term investment strategies (4th ed.), McGraw-Hill, New York.

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