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Group 1. Becca Massanova , Alex Villar , Andrew rosenman , sharan kaur. Overview. Mary has a risky and undiversified portfolio. Bill needs to help her understand the technical terms and how to manage a portfolio. Mary needs to know how to lower the risk of her portfolio. Risk & return.

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group 1

Group 1

BeccaMassanova, Alex Villar, Andrew rosenman, sharankaur



Mary has a risky and undiversified portfolio.

Bill needs to help her understand the technical terms and how to manage a portfolio.

Mary needs to know how to lower the risk of her portfolio.

risk return
Risk & return
  • The principle that potential return rises with an increase in risk. Low levels of uncertainty (low risk) are associated with low potential returns, whereas high levels of uncertainty (high risk) are associated with high potential returns.
  • As risk rises potential return rises as well
  • To receive higher returns one must to invest in riskier assets.
  • Beta is a measure of individual stock risk relative to the overall risk of the stock market
  • Measures the sensitivity of a stock’s price compared to market movements
  • Stocks with betas above 1.0, have a stronger connection with of the behavior of the market
  • Stocks with betas between 0 and 1.0 move in the same direction with the market
  • Because the market is the portfolio of all the stocks, the average stock has a beta of 1.

Market risk- is the risk that affects the overall stock market, this cannot be changed and its beta always equals 1

Unique risk- is the risk of only one firm. This risk can be either high or low and can be changed.

Diversification-you want to diversify the risk of the stocks in order to bring the risk as close to market risk as possible. Have some low risk and some high risk stocks to balance out the risk.

This graph shows how when there is one stock the volatility is higher then when there are more stocks that diversify the risk and bring it closer to market risk.

tips for undervalued stocks

Tips for Undervalued Stocks

Look at stock’s debt to equity ratio

Lower the debt and higher the equity= better chance for stock to grow

Look at revenue growth for the past couple quarters

Make sure the stock has been undervalued only for a couple quarters. You want to make sure it has potential to become overvalued.

Look for dividends

Make sure the stock has decent dividends, so while you are waiting for it to become overvalued you are still collecting a profit.

You want to make sure the stock will grow

security market line1
Security Market line
  • SML used to determine if various stocks are overvalued or undervalued given a certain Beta.
  • Market Beta=1, Risk-free Beta=0
  • SML is a line that connects these 2 points and goes on forever both ways.
  • Stock’s expected return lies above SML, then stock is undervalued (Counter-cyclical/Utility) and investor can expect a greater return for same inherent risk
  • Stock’s expected Return lies below SML, then stock is overvalued (High-Tech) and investor can expect a lower return for amount of risk assumed.
portfolio stocks
Portfolio stocks
  • Utility Co Beta=0.21, undervalued and earning almost double the expected return on the market.
  • High-tech Co Beta=1.93, overvalued and is earning a lower expected return than the market at its given beta.
  • Counter-cyclical Co beta=-1.01, undervalued and earning about 50% more than the market.
high tech and counter cyclical stocks
High-Tech and Counter Cyclical Stocks
  • Expected Return=5.42%
  • Risk Level(STD)=21.45%
  • Not Realistic
    • Would only be certain if STD=0
    • We cannot tell what the outcome will be
  • Mary should not invest in these stocks equally because they are both highly risky and unpredictable.
portfolio weighting
Portfolio weighting
  • Mary invests 70% hig-tech and 30% index fund, ER=(0.7*5%)+(0.3*5.9%)=5.27%. This is likely to be a lower return.
  • Lower expected return on this portfolio than a portfolio invested half in high tech stocks and other half in counter-cyclical stocks
  • Reason for declining expected return is because there is more invested into high-tech stocks which is overvalued.
  • Mary said she wanted to reduce risk and we believe that it is the best option for her.
  • She should shy away from high-tech stocks because they are overvalued and a riskier asset.
  • Invest more into T-Bills and Utility Co. stock.
  • T-Bills are risk free and Utility Co. stock is a lot less risky and providing nearly double the expected return on the market at beta=0.21.