Business Finance: Expected Stock Returns And Volatility Essay

Question:

Discuss about the Business Finance for Expected Stock Returns and Volatility.

Answer:

Mean Return

Mean Return is the sum of all the returns of a certain security in a certain period divided by the number periods (French & Schwert, 1987). This measure is important as it is used to determine which company has higher expected return and therefore it can be used by potential investors to make valuable decision on which company to invest. Company with high mean return is preferred by investors as compared to that with low mean return because high mean return means high expected returns to the investor. In the case of News Media Ltd and HR Resources Ltd, HR Resources Ltd will be attractive to the investor as it has a potential return of 0.3391 every month compared to News Media Ltd which has a potential return of 0.1696.However, the two companies mean return is far much below the market mean return which is 38.04.This means that the two companies are not expected to do well when compared to other companies in the market.

The Standard Deviation

It is a measure of how spread the returns are from the mean return. It is indeed the square root of the variance of the security returns ( Djulbegovic & Hozo, 2005). The higher the standard deviation the higher the volatility of the company`s security return and vice versa. The standard deviation for News Media Ltd is 0.96%,this means that the likelihood of actual returns of this security to differ from the mean return is 0.96% and that of HR Resources Ltd is 0.84%.Thus according to the two standard deviation, News Media Ltd is considered more volatile than HR Resources Ltd and risker.

The Coefficient Of Variation

It is the ratio of standard deviation to the Mean (Brigham & Houston, 2012). This measurement is useful when one wants to compare the outcomes from two scenarios or companies. For example the coefficient of variation of 5.68% in the case of New Media Ltd indicates that the returns for this company have a variation of 5.68% relative to the Mean and that for HR Resources Ltd has a variation of 2.47% relative to its Mean. Therefore New Media Ltd has more variation, relative to its Mean. This means that New Media Ltd is more risky compared to HR Resources Ltd.

The Correlation Coefficient

It measures the degree to which two factor`s movements are related (Mukaka, 2012). The range for correlation coefficient is -1 to 1.A value of -1 denotes a ``perfect negative correlation’’ and that of 1 denotes a ``perfect positive correlation’’.The correlation between New Media Ltd and HR Resources Ltd is -0.45.This means that there exist weakly negative correlation between the two companies.

Standard Deviation Of Returns For A Portfolio

It measures how spread the fund’s returns are from the expected normal returns of a two or more combined stocks (Duchin & Levy, 2009). The deviation in this case for New Media Ltd and HR Resources Ltd is -0.11.This means that deviation in case of a portfolio is less than of holding individual stock. Thus holding a portfolio of the two stocks would be less risky than holding individual stock.

Beta Coefficient

It measures how the sensitive the share price is to the movement in the market price. It is the best measure of systematic risk (Fabozzi & Francis,1978). It is prevalently used in capital asset pricing model to get required rate of return. A beta of -1.29 for New Media Ltd indicates that this security has a risk and return that is below the average (the market risk and return).For HR Resources Ltd a beta of 2.55 indicates that this security has a risk and return that is above the average. Thus New Media Ltd has a lower risk and return while HR Resources Ltd has a higher risk and return.

References

French, K.R., Schwert, G.W., 1987. Expected stock returns and volatility. Journal of financial Economics, 19(1), pp.3-29.

Djulbegovic, B. and Hozo, I., 2005. Estimating the mean and variance from the median, range, and the size of a sample. BMC medical research methodology, 5(1), p.13.

Brigham, E.F. and Houston, J.F., 2012. Fundamentals of financial management. Cengage Learning.

Mukaka, M.M., 2012. A guide to appropriate use of correlation coefficient in medical research. Malawi Medical Journal, 24(3), pp.69-71.

Duchin, R. and Levy, H., 2009. Markowitz versus the Talmudic portfolio diversification strategies. The Journal of Portfolio Management, 35(2), pp.71-74.

Fabozzi, F.J. and Francis, J.C., 1978. Beta as a random coefficient. Journal of Financial and Quantitative Analysis, 13(1), pp.101-116.

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