Question

Essay questions:

Please describe the various forms of measures that we can implement within equity and fixed income portfolios that would help us monitor the levels of risks within the portfolios (describe these measures).

Answer 1

The various forms of measures that we can implement to monitor the level os risks within equity and fixed income portfolios are as follows:

1. Beta:

Beta is the amount of systematic risk that a single security, particular sector in the industry has compared to the whole stock market. The market always has a beta equal to 1 and it can be utilised to index the risk of a security. If a security's beta is equal to 1, the security's price moves in the same direction with the market. A security with a beta of more than 1 indicates that it has higher volatility as compared to the market. On the other hand, if a security's beta is less than 1, it indicates that the security has less volatility compared to the market.

Example: Security's beta = 1.25. In theory, the security is 25 percent more volatile than the market.

2. Standard Deviation:

Standard deviation calculates the dispersion of data series from its expected value i.e. mean. Standard deviation is commonly used in making investment decisions in order to measure the amount of volatility in the past associated with an investment relative to its annual rate of return. It is an indicator of how much the current return is deviating from its expected historical returns normally. Example: Stocks with higher standard deviation have higher volatility, and ultimately, a higher degree of risk will be associated with the stock.

3. Value at Risk (VAR)

VAR is a statistical measure which is broadly utilised in assessing the levels of risk which is associated with a portfolio of securities or a single stock. Value at Risk (VAR) measures the maximum potential loss with a degree of confidence for a particular time period. Example: portfolio of investments having a one-year 5 percent VaR of $10 million.indicate that the portfolio have a 5 percent chance of losing more than $10 million over a one-year time period.

4. R-squared

R-squared is another statistical measure which depicts the percentage of a fund portfolio's movements which can be described by movements in a benchmark index. For a portfolio of fixed-income securities , the benchmark could be the U.S. Treasury Bill. The S&P 500 Index can be a benchmark for equities and portfolio of equities. R-squared values range on a scale from 0 to 100. A portfolio of securities with an R-square value close to 100 has a performance record that is highly correlated to its index. Conversely, lower R square values depict diversion from its index.