Assignment Fm week 4

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Assignment

Types of Risk

View the following Video: This video introduces the concept of business risk and risk management. It notes that business risks can generally be classified into four categories: property, market, employee, and customer.

http://searchcenter.intelecomonline.net/playClipDirect.aspx?id=4870EEC7664070BB9D6744FDA7325EE409273F0294E05CB605BD2644A49FA1711B997988CEF21D86EF438737AEFFE09D

Using each of the four categories of risk, develop an analysis of how financial management techniques or policies can be used to mitigate each of the risks. To supplement your risk analysis, you must use at least one article for each of your risk mitigation techniques or policies from the Ashford University Library.

Summarize your findings in a three- to five-page paper (excluding the title and reference pages) that is formatted according to APA style as outlined in the Ashford Writing Center. Be sure to properly cite at least four scholarly sources using APA style.

Instructor’s Comments

Risk and Reward

Risk is defined by Webster as “a hazard; exposure to loss or injury. Risk is about the chance that some unfavorable event will happen. As an asset, risk can be sub-divided into two types (1) on a stand-alone basis and (2) on a portfolio basis. Stand-alone risk is the item or project’s risk if it is held as a lone asset. It does not consider the fact that it is but one asset within a portfolio of assets and is but one stock in a typical investor’s portfolio of many stocks. Stand-alone risk is measured by the variability of the project’s expected returns. Corporate, or within-firm, risk is the project’s risk to the corporation; hence some of its risk will be eliminated by diversification within the firm. Corporate risk is measured by the project’s impact on uncertainty about the firm’s future earnings. Market, or beta, risk is the riskiness of the project as seen by well-diversified stockholders who recognize that the project is only one of the firm’s assets and that the firm’s stock is but one small part of their total portfolios. Market risk is measured by the project’s effect on the firm’s overall variability.

It is often difficult to quantify market risk, on the other hand, we can usually get a good idea of a project’s stand-alone risk, and that risk is normally correlated with market risk. The higher the stand-alone risk, the higher the market risk is likely to be. , Consequently, there is a tendency to focus on stand-alone risk, then deal with corporate and market risk by making judgmental modifications to the calculated stand-alone risk.

People are generally risk averse and are usually willing to pay a premium to decrease the uncertainty of future cash flows. Conversely, it can be stated, the higher the risk the higher the expected return. The increasing availability and access to international securities is making it possible to achieve a better risk-return trade-off than could be generated by investing only in U.S. securities. Thus, investing in foreign securities could potentially result in a portfolio with less risk but a higher expected return. This is due in part to a low correlation between the returns on U.S. and international securities along with potentially high return on foreign investments.

Weighted Average Cost of Capital

Every firm has an optimal capital structure, which is a mix of debt, preferred, and common equity that causes its stock price to be maximized. A value-maximizing firm will continually develop, understand and manage its capital structure. It will establish its optimal capital structure, use it as a target, and then raise additional capital in a manner that will keep the actual capital structure on target over time. The target proportions of debt and equity, along with the costs of those components, are used to determine the firm’s weighted average cost of capital, (WACC). Note: A firm weights (debt vs. equity) could be based either on accounting values shown on the firm’s balance sheet or on market values of various securities. In theory, the weights should to be based on market values, but if a firm’s book value weights are reasonably close to its market value weights, book value weights can be used as a proxy for market value weights.

References:

Ehrhardt, M.C. & Brigham, E.F. (2011) Financial management:Theory and practice 13th ed, Southwestern Cengage Learning.

Gitman L.J. & Joehnk, M. D., (2008) Fundamental of Investing, 10th ed., Pearson Addison Wesley, Boston.

Brigham, E. F. & Houston J. F., (2009) Fundamental of financial management, 12th ed, Southwestern Cengage Learning, Mason OH.

http://searchcenter.intelecomonline.net/playClipDirect.aspx?id=4870EEC7664070BB9D6744FDA7325EE409273F0294E05CB605BD2644A49FA1711B997988CEF21D86EF438737AEFFE09D