The Concept of Risk Aversion is Fundamental to Investment Analyses: Statement Evaluation
‘The concept of risk aversion is fundamental to investment analyses’ – A statement evaluation
Risk is almost always present when an investment is taken; the evaluation of risk begins immediately with analysts asking questions about the level of risk associated with an investment, performing calculations to measure the risk involved, also diversifications may be considered to minimise risk. This clear focus and proactive approach to risk minimisation implies risk aversion plays a major role in the analysis of investment opportunities.
Information Gathering
Before any computations can be performed or diversification needs considered a financial analyst must first acquire information about potential investments by asking questions, such as ‘What is the desire of the investor?’, ‘How big is the risk to the investor?’ ‘What risk is acceptable to the investor?’ ‘What is the trade-off?’ Not only do these questions ensure the analyst is fulfilling the desires of their client by ascertaining their aversion to risk, (Lintner, 1965, p. 596) they also tellingly depict an underlying reserved nature.
Computations
There are a range of calculations that exist to measure the likeliness of risk associated with any potential investment. Some of the computations include formulas such as, the risk premium, beta, and standard deviation. The risk premium calculates the added return anticipated for taking on extra risk (Petty, 2012, p. 279). The formula beta, also known as financial elasticity, uses regression and measures the volatility of the relationship between an investment and the rest of the market (Petty, 2012, p. 297). Additionally, the standard deviation (the spread of the values from the average) calculates an investment 's volatility by being applied to the annual rate of return, the higher the outcome the more unstable the investment is considered to be. All of these calculations, and others, are used with the aim of measuring the riskiness of potential
Risk is almost always present when an investment is taken; the evaluation of risk begins immediately with analysts asking questions about the level of risk associated with an investment, performing calculations to measure the risk involved, also diversifications may be considered to minimise risk. This clear focus and proactive approach to risk minimisation implies risk aversion plays a major role in the analysis of investment opportunities.
Information Gathering
Before any computations can be performed or diversification needs considered a financial analyst must first acquire information about potential investments by asking questions, such as ‘What is the desire of the investor?’, ‘How big is the risk to the investor?’ ‘What risk is acceptable to the investor?’ ‘What is the trade-off?’ Not only do these questions ensure the analyst is fulfilling the desires of their client by ascertaining their aversion to risk, (Lintner, 1965, p. 596) they also tellingly depict an underlying reserved nature.
Computations
There are a range of calculations that exist to measure the likeliness of risk associated with any potential investment. Some of the computations include formulas such as, the risk premium, beta, and standard deviation. The risk premium calculates the added return anticipated for taking on extra risk (Petty, 2012, p. 279). The formula beta, also known as financial elasticity, uses regression and measures the volatility of the relationship between an investment and the rest of the market (Petty, 2012, p. 297). Additionally, the standard deviation (the spread of the values from the average) calculates an investment 's volatility by being applied to the annual rate of return, the higher the outcome the more unstable the investment is considered to be. All of these calculations, and others, are used with the aim of measuring the riskiness of potential
References: Fischel, F. H. (1985). Limited Liability and the Corporation. The University of Chicago Law Review, 52(1), 89-117. Kris Kemper, A. L. (2012). Diversification revisited. Research in International Business and Finance, 26(2), 304-316. Lintner, J. (1965). SECURITY PRICES, RISK, AND MAXIMAL GAINS FROM DIVERSIFICATION. . The Journal of Finance, 20(4), 587-615. Petty, J. W. (2012). Financial Management: Applications and Principles (6th ed.). Frenchs Forest: Pearson Australia Group Pty Ltd.