CORPORATE FINANCE CASE ASSIGNMEN 3 Risk and return, portfolio Essay

CORPORATE FINANCE CASE ASSIGNMEN 3 Risk and return, portfolio diversification and the Capital Asset Pricing Model; The cost of equity - Essay Example It depends on the risk involved in that investment. Hence the investment decision is dependent on the returns, the risk involved (amount of uncertainty in generating the expected returns) and also the investor’s utility indifference (attitude towards risk and expected returns). A risk averse individual will always aim to reduce the risk involved in his investments and ensure a high return. The investor, in light of the level of risk tolerance, must establish specific return objectives. On the basis of these objectives, he/she can opt for a varied portfolio of investments. Diversification is a way to limit or reduce the risk. Diversification is the balancing act in which the risk-return tradeoffs are adjusted. This implies the concept of relativism and indicates that it is superior to that of absolutism (Ware). Owning a number of investments can reduce the risk involved in an investment. This is called portfolio diversification. This could be by owning shares in a number of different countries or by investing in different asset classes such as fixed interest or property (Bekiaris). Investing in a wider range of domestic stocks and cash, short, mid and long-term bonds, foreign currency-denominated bonds, equity sectors, foreign stocks and emerging market sto cks can reduce the risks involved in the investment (Donald). As mentioned earlier, there are three methods that can be used to estimate the rate of return for Federal Express. These include, Dividend Growth, CAPM, and APT. The Dividend growth model is one which requires the current dividend rate, the constant growth rate of the dividend and the required rate of return. Here in this model a summing of the infinite series is done to get the value of the current price. This model also requires a few more details that need to be provided in order to compute the arithmetical calculation. These include the value of ‘g’, the current rate of return‘d’. One of the biggest drawbacks of this