Question

Explain how stand-alone, market and corporate risk would be applied to Large Investor Owned health systems, small-investor owned health systems and not-for profit businesses. Be sure to think about not only the different corporate legal structures noted above, but also, specific capital structures and specific project scenario analysis results of standard deviation and coefficients of variation as described above.

Just focus on Large Investor Owned, Small Investor Owned and Not For Profit businesses

Answer 1

Stand-Alone Risk

All financial assets can be examined in the context of a broader portfolio or on a stand-alone basis, when the asset in question is thought to be isolated. While a portfolio context takes all of the investments and assessments into account when calculating risk, stand-alone risk is calculated assuming that the asset in question is the only investment that the investor has to lose or gain. In other words, the stand-alone risk is the risk associated with a single operating unit of a company, a company division, or asset, as opposed to a larger, well-diversified portfolio.

Stand-alone risk involves the risks created by a specific asset, division, or project. It risk measures the dangers associated with a single facet of a company's operations or the risks from holding a specific asset, such as a closely held corporation. For a company, computing stand-alone risk can help determine a project's risk as if it were operating as an independent entity. The risk would not exist if those operations ceased to exist.

In portfolio management, stand-alone risk measures the risk of an individual asset that cannot be reduced through diversification. Investors may examine the risk of a stand-alone asset and help predict expected return of investment. Stand-alone risks have to be carefully considered because as a limited asset, an investor stands to either see a high return if the value of the asset increases since it is the sole asset. On the other hand, an investor could stand to lose the entire value of the asset because it is the only one.

Example of Stand-Alone Risk

Stand-alone risk can be measured with a total beta calculation or through the coefficient of variation. Beta reflects how much volatility a specific asset will see relative to the overall market. Meanwhile, total beta (which is accomplished by removing the correlation coefficient from beta), measures the stand-alone risk of the specific asset without it being part of a well-diversified portfolio.

The coefficient of variation is a measure used in probability theory and statistics that creates a normalized measure of dispersion of a probability distribution. After calculating the coefficient of variation, its value can be used to analyze an expected return along with an expected risk value on a stand-alone basis.

For example, a low coefficient of variation would indicate a higher expected return with lower risk, while a higher value coefficient of variation would lend itself to having a higher risk and lower expected return. The coefficient of variation is thought to be especially helpful because it a dimensionless number, meaning that, in terms of financial analysis, it does not require the inclusion of other risk factors, such as market volatility.

Stand-Alone Risk

Recall that Beta is a number describing the correlated volatility of an asset or investment in relation to the volatility of the market as a whole. However, appraisers frequently value assets or investments, such as closely held corporations, as stand-alone assets. Total Beta is a measure used to determine the risk of a stand-alone asset, as opposed to one that is a part of a well-diversified portfolio. It is able to accomplish this because the correlation coefficient, R, has been removed from Beta. Total Beta can be found using the following formula:

Total Beta = β/R

Another statistical measure that can be used to assess stand-alone risk is the coefficient of variation. In probability theory and statistics, the coefficient of variation is a normalized measure of dispersion of a probability distribution. It is also known as unitized risk or the variation coefficient. In terms of finance, the coefficient of variation allows investors to determine how much volatility (risk) they are assuming in relation to the amount of expected return from an investment. Volatility is measured in the form of the investment’s standard deviation from the mean return, thus the coefficient of variation is this standard deviation divided by expected return. A lower coefficient of variation indicates a higher expected return with less risk.