The Return and Risks of ASCIANO - AIO Company - Report Example

Executive summary ASCIANO – AIO Company is an Australian Freight logistic corporation operating in railways freight as well as shipping with over 8,000 employees. The company was demerge from Toll corporation in the year 2007 as well as a subsidiary investment in Patrick corporations and pacific national Asciano focuses on huge as well container shipping and transportation with port and train transactions in Australia. The company is an ASX 50 CORPORATION. This report provides an overview of the expected return and risk of portfolios consisting of stocks listed on ASX, which is the ASCIANO – AIO Company. Firstly, the risk and return of the combined portfolio will be examined by applying mean-variance approach, followed by the portfolio analysis using the regression approach including the justification of data selection, information of the rationale and calculated results. Then, the recommendation will be provided with consideration of assumptions and limitations under the two approaches and analyzing the results the calculations in concluding whether it is ideal to hold a single investment or a portfolio to minimize risk from investment. Systematic and unsystematic risk Systematic risk is the risk that can affect individual company, thus the risk is unique to the business and this they are risk caused by internal factors of the firm, and consequently they are controllable. Unsystematic risk This risk on the hand is the risk that is beyond the control of the firm. The risk is caused by external factors beyond the control of the firm (Arnold, 2005). An example of this risk that affected the company is the infamous Global Recession of 2008/2009, which had an impact that could not be underestimated .the consequences, affected the whole world including the Australian companies. Looking at Figure 1 below, it is evident that this crisis led to extremely lower share prices – close to 1.00 – all the way from its previous value of close to 10.00 back in January 2008. The crisis was so intense that for the six years, this was the lowest share price ever in the history of AIO. Another example of unsystematic risk that is beyond the control of the business is the escalating tensions between Ukraine and Russia, which began when a passenger jet was shot down in Ukraine. This led to tensions between Russia and the Western countries, and it was suspected that this acrimony could have led to a dip in the global markets (Matt, 2014). In AIO’s case (from Figure 2), it can be seen that though negligibly small, the returns for the company dipped by some margins. What, however, became apparent later on is that the acrimony did not have much of an impact in the global markets, as was widely speculated (Matt et al., 2014). All this factors are beyond the control of the company and might significantly affect the business operation consequential from downfall in economic performance. In this regards, the busines should hold diversification of portfolio in order to minimize business risk as well as diversified business opportunity and investment. Under perfect market, every signal investor have very same information, capital for investment, and technological judgment, there is no arbitrage opportunity. The market equilibrium makes every investor has same market portfolio. Generally, the market portfolio is considered an effective portfolio. However, the estimation of systematic risk will be wrong, when the incorrect portfolio and market index are chosen (Roll, R, 1977). Also, the behavior of market participant as the more important role affects market prices to be informational inefficient .Risk and return of the combined portfolio is assessed by applying mean-variance approach, followed by the portfolio analysis using the regression model (CAPM approach) including the justification of data selection, information of the rationale and calculated results., the recommendation will be provided with consideration of assumptions and limitations under the two approaches and analyzing the results of the calculations. The relation between risk and return is that of an inverse proportion since, the higher the risk of a return, the high the returns and consequently, to capitalize on this and at the same time reduce the risk from the investment, an investor should consider holding a portfolio of securities. Component cost of capital is ideal in ascertaining the value of the firm since, cost of capital provides guideline o calculating the cost of equity as well as cost of debt and consequently the weighted average cost of capital. By doing so, it will be easier in concluding on whether to invest or not an investment project. Comparison the return and risks of ASCIANO – AIO Company and the overall stock market index over the eight-year period. AIO stock price from January 2008 to janauary2015 has gradually increased overtime since 2008, without any dramatic drop or rise in the stock price over this particular period of time ad depicted in the table above. Calculation of Beta (β) Beta (β) also known as coefficient of X variables suing regression model, is a measure of the sensitivity of the stock price relative to the change in the whole market. It measures the systematic (non-diversifiable) risk of a company relative to the market index (Manickaraj and Loganathan 2004).In calculating the beta, the company monthly historical data since January 2008 to 2014 are used. The specific time is chosen as to avoid any dramatic fluctuations in the company’s historical data because of Global Financial Crisis in 2008- 2009. A 51 months period of monthly data is believed to be sufficient to provide a reliable result that will represent beta (β). Interpreting the Beta of individual stock return Graph of Portfolio Combination The graph below shows a positive relationship between portfolio beta and the expected return in a growing market, where beta indicates the relationship between stock and market. The analysis is concluded at by using the Mean Variance Analysis. The analysis is developed by Markowitz (1952). It is recognized that every rational investor, at a certain level of risk, will accept only the largest expected return, or the lowest level of risk with a certain expected rate of return. Under this approach, expected returns and risks is calculated based on the historical returns. The calculated results of the portfolio return and standard deviation represent the investment return and risk Market Index All Ordinaries Accumulated Index is used as the market index represents 500 largest companies including ASCIANO – AIO Company. Moreover, accumulation index is being used instead of the non-accumulated because it takes into account both price growth and dividend income and assumes that dividends are reinvested back (ASX 2014). The detailed monthly All Ordinaries Accumulated Index can be found in the excel. From the above data analysis, it can be observed that the market returns is quite low as observed by monthly returns. This therefore implies that the business performance for the ASCIANO is ideal and consequently the business is a going a concern since, the business risk is low From the above comparison of stock return a standard deviation for market and individual return depict that individual stock returns is much as higher as compared to returns of the market. The interpretation is that investment in ASCIANO – AIO is a viable venture since investors will realize returns inform of profit much as compared to market returns and performance. The standard deviation of the individual company’s return is high as compared to market standard deviation hence implying that the venture proposal is risky in terms of volatility as a result, an investor considering investing in this risky venture with high returns should consider holding a portfolio of returns in order to diversify the risk. The capital asset pricing model provides that a rational investor should consider investing in that risky venture with high return as well as low component cost of capital in order to maximize the investment opportunity. The above comparison depict that investment in healthcare is a risky venture with high returns and thus it is a good opportunity for investors. The standard deviations of Market and individual firms are 4.2% and 18.64% respectively. After calculating with CAPM approach in excel, the expected returns of Market and individual firms become 0.14% and 1.42%. As the average risk premium is positive (2.88), the individual firms, which have a higher standard deviation (2.88) gives a higher expected, return (103.12%). According to the CAPM theory, the relationship between standard deviation and market sensitivity is positive (Bos, 1984). This indicates that a higher standard deviation gives a higher risk. When choosing an optimal portfolio in this report, the one with the lowest standard deviation should be considered. Therefore, portfolio with the lowest standard deviation/risk (0.0576326) is the one we considered as the optimal one. There are two reasons why we choose the portfolio as an ideal investment strategy. Firstly, as the expected return of market is 0.014%, the expected return of market after using CAPM formula in excel is 1.42%. This indicates that the true value of market stock is underestimated; hence, the weight of market in a recommended portfolio should be relatively higher, which must roughly be 60% above average to minimize investment risk. Secondly, holding portfolio of returns will have small fluctuation of the expected return of different portfolios is very small. The maximum expected return is 103.12% and the minimum one is -59.8%. Therefore, we can consider the expected returns are almost the different in different. So at a given level of return, the minimized risk investment in this report should be recommended for a risk adverse investor. SUMMARY OUTPUT Regression Statistics Multiple R 0.008373 R Square 7.01E-05 Adjusted R Square -0.01292 Standard Error 0.188047 Observations 79 ANOVA   df SS MS F Significance F Regression 1 0.000191 0.000191 0.005399 0.941616 Residual 77 2.722847 0.035362 Total 78 2.723038         Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.000844 0.184086 0.004586 0.996353 -0.36572 0.367406 -0.36572 0.367406 X Variable 1 2.88E-06 3.92E-05 0.073478 0.941616 -7.5E-05 8.09E-05 -7.5E-05 8.09E-05 Conclusion An investor must consider a portfolio of investment in order to minimise the risk. Under the CAPM, method, a diversified portfolio depicts less business risk as compared to individual stock returns. In CAPM suing regression model, standard deviation and market comparison with individual returns is an important indicator that measures the systematically risk of stock for ASCIANO – AIO. However, is beta accurate enough to explain expected return? In early stage, most the empirical research can support CAPM. Sharpe (1972) would be the first one who showed the expected return and beta are followed by liner relationship. Black, Jensen and Scholes (1972) also provided the same conclusion. In the real world, investment happens not only in one period, it can be affected by many time horizons. According to Merton’s (1973) statement, investing behaviour should be an inter-temporal capital allocation. CAPM approach normally measures only in one time horizon, so the result accuracy will be affected. According to Markowitz (1952), portfolio theory assumes that a portfolio, which gives both maximum, expected return and minimum variance, is recommended to the investor. However, in practice application, the portfolio with maximum expected return is not necessarily the one with minimum variance. There is a rate at which the investor can gain expected return by taking on variance, or reduce variance by giving up expected return. Based on the assumption which is that investors are rational and risk averse, it is recommended that investors should choose the portfolio with the minimum variance and relatively higher return as observed from the excel work attached This could be seen in the figure in which the curve reaches the point with smallest level of risk. whether an investor is better off investing solely in the company or in a portfolio It is clear has depicted in the excel work where that an investor should consider investing a portfolio. as observed above, the Beta of the individual stock return is 2.8 while the Beta for market return is 0.000844.It is therefore evident that the market returns (Portfolio) depict a small co-efficient which is there a less risk venture since, the returns is less volatile as compare to the volatility rate of individual return which is quite high. as a result, an investor should consider holding a diversified invest (Portfolio) since, there is low volatility rate with high value. An investor must therefore consider the investment risk as well as the appropriate decision of nature of investment portfolio in order to ensure that there is less investment risk with high returns inform of profit. Investment risk is the risk that a company might fail to realize investment inform of profit from the security venture invested. In order to minimize risk of a return investor should thus consider holding a portfolio of securities in order to diversify the degree of risk. In this regards, risky ventures will have been minimized since, according to weighted average cost of capital (WAACC), it depicts that the returns of a portfolio would provide a higher value with lower cost of capital unlike a single security investment that will depict a return with higher cost of capital with lower value which is too risky to invest in.. It can therefore be concluded that the relation between risk and return is that of an inverse proportion since, the higher the risk of a return, the high the returns and consequently, to capitalize on this and at the same time reducing the risk from the investment, an investor should consider holding a portfolio of securities (coefficientl, 2003). Component cost of capital is ideal in ascertaining the value of the firm since, cost of capital provides guideline o calculating the cost of equity as well as cost of debt and consequently the weighted average cost of capital. By doing so, it will be easier in concluding on whether to invest or not an investment project. An empirical study depicts that, a levered firm (financed by Mix of debt and equity) commands a higher value with low component cost of capital unlike the unlevered firm and consequently, it implies that, an investors should consider investing in a levered firm since, there is low risk on investment thus investors will realize investment in form of profit within the short time. Reference List 2 . Arnold, Glen (2005). Corporate financial management (3. ed. ed.). Harlow [u.a.]: Financial Times/Prentice Hall Ltd, pp. 354. 5. Black, Fischer, Michael C. Jensen and Myron Scholes, 1972, The Capital Asset Pricing Model: Some Empirical Tests, in Studies in the Theory of Capital Markets, Michael C. Jensen, ed, New York: Praeger, 79-121. 6. Blake, T. 2005,The Bootstrap Theorem: Creating Empirical Distributions, Fundamentalfinance.com, viewed 26 April 2013, 7. Blume M. 1971, ‘On the Assessment of Risk’, The Journal of Finance, Vol. 26, No.1, pp1-10. 8. Bos, P. and Newbold, J. 1984, An empirical investigation of the possibility of stochastic systematic risk in the market model, Business, vol 57, pp. 43-41 9. Bowman, R.,2001, Estimating the Market Risk Premium: The Difficulty with Historical Evidence and an Alternative Approach, JASSA, 3, pp. 10-13. 10. Bradfield D. 2003, Investment basics on estimating the beta coefficient. Investment Analysts Journal. , vol 57, pp. 47-53 Read More