Question

Discuss the different approaches to adjusting for risk when valuing companies and/or assets? List the advantages and disadvantages of each.

Answer 1

Answer:-

Hope its helps.

Value at Risk (VAR) is a method in the risk assessment which does away with the limitations of the old method of risk assessment i.e. volatility. It also talks about the direction of the investment which is done by you. With the help of directions, we can answer the question that how much could be the maximum loss i.e. the worst case scenario. It consists of three part - the time period of the investment, confidence level, and the percentage of possible loss. There are three ways to calculate it -

On the basis of historical trends of returns, with the help of Variance-Covariance method, and by developing future stock price with multiple hypothetical trails.

The advantages of this method are that it can tell you the worst case scenario which wanst explained before, it is easy to understand and interpret.

The disadvantages are that it can give a false sense of security, its difficult to calculate in the large portfolios, and confusing in the sense that different methods lead to different results.

Historical approach talks about interpolation and extrapolation taking the historical returns. It works on the assumption that history repeats, whereas the model-based approaches do it by developing future stock price with multiple hypothetical trails.