Risk and Return for BHP Billiton - Example

Executive summary Introduction BHP Billiton is a worldwide natural resource corporation .The business was registered and put into operation in the year 2001 by the amalgamation of BHP and Billiton Plc. The business is in the dealing of mining of ore, steel oil, and gasses. The business as a subsidiary investment BHP Iron Ore (Jimblebar) Pty Ltd with a share investment worth 85 % .The subsidiary business invests in iron ore mining,the percentage of ordinary shares held in principal subsidiaries is disclosed in Note 26 to the note to financial statement ‘Subsidiaries’. Introduction This report provides a summary of the expected return and risk of portfolios comprising of stocks listed on ASX for BHP Billiton. The risk and return of the a portfolio will is appraised by using the capital asset pricing model as well as making an assessment of portfolio performance in the stock market and providing conclusive report on the performance of the stock based on their viability and volatility rate (Bowman, JASSA). The assessment is based on the validity of the data selected, the underlying principle of information and the outcome of the report taking into consideration the assumption in suing capital asset pricing model as an investment appraisal tool. The Systematic risk The Systematic risk is the risk that can be controlled by the management since, the risk affect the internal business operation such as the financial distress, poor governance as well as the risk is unique to the business which implies that it can be controlled by the management. Unsystematic risk Unsystematic risk is the risk that affects the entire economy such as the effect of inflation on the performance of the business on the risk in a country that creates instability in economy. This is the risk that is beyond the control of the management and thus it can be controlled by having asset diversification and holding portfolio returns in on order to minimize risk (Bos, 1984). An example of the risk that affect the business is the decline in global market price of the ore that leads to reduction in level of net income to the business as well as the effect of global recession of 2008/2009 that affected the business operation drastically. As observed in the table below, the effect of global recession, lead to a reduction in the level of BHP stock price unlike those of the market. The stock price for BHP is 0.2907 while those for the market are 0.0442. Thus, this is the least share that is reported in the 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 The effect of global recession on stock price lead to downfall of BHP stock price by 43% for the last one year while the market depict a decline by 30%.In the mid 2009, the company adopted the procedure of declining to offer remedy to European antitrust commission which Implies that the company reduced their expense as well as risky dealings that aught be significant to attain the fair divestment worth at the time of economic recession. Across, Australia, the war Ukraine and Russia is an example of unsystematic risk that might affect the business operation after recovering from economic depression. The war creates tension between Russia and other developed nation, which hinders economic integration as well as share price performance in the stock market. The effect of Russia and Ukraine war on the global economy and security price is that it makes the NHP stock price to underperform as the graph depict that the market stock is quite high unlike those of the BHP Billiton. It is evident that the stock return is declining These factors are beyond the control of the company and thus it affects the business operation drastically due to stunted economic growth. The market portfolio is an efficient portfolio since, there is reduced volatility rate. Nevertheless, the approximation of systematic risk is misleading where the incorrect portfolio as well as market index is selected. The trait of the market plays a key role in market price performance in terms of efficiency. Risk and return of the combined portfolio is appraised by using the capital asset pricing model in suing portfolio assessment of data and the output of the result. There is a constructive connection between risk and return since, the higher the risk of investment, the higher the volatility rate is observed by the value of variance of the returns. The portfolio risk and return is assessed by employing the CAPM (regressor model) since, the risk and return depict an inverse relation of an investment. There is presence of strong connection between risk and returns, implies that the distribution around the mean from line of best is zero in using the scatter graph to interpret the risk and return relationship. The link between risk and return is therefore clearly explained by the above graph since, it can be observed that the high the return of a stock, the higher the volatility rate it carries. In order to make certain that there is high return form a uncertain asset, one must deem holding portfolio of return in view of the fact that, it carries small component cost of capital with high return that end result means that holding a portfolio of security curtail the unpredictability of the returns (Arnold, 2005). Component cost of capital is decisive in establishing the value of the firm for the reason that cost of capital provides principle in concluding at the cost of equity and of debt, thus it will be easier in approximating whether to venture or not an investment development Comparison the return and risks of BHP Billiton Company and the overall stock market index over the eight-year period. BHP Billiton stock price depict an increasing trend from January 2008 to janauary2015, devoid of any spectacular decline or an increase in the stock price over the specified period of time ad depicted in the table above. As result, the business should therefore diversify its investment in order to mitigate the effect of global financial crisis that has affected the business as past. The good reason for appreciating the portfolio returns as an important investment plan is the expected return of a portfolio. A portfolio expected return depict allow cost of capital with high return which implies investment in stock will earn more return since its volatility rate is low. The table above depict that the market return for stock is high with low risk on return. the impact of the stock diversification as well as holding portfolio create reduction of risk in returns and maximize the worth of the return in of profit (Annaert, 2005). As a result, an investor will deem holding a portfolio of security to minimize investment risk as well as improve the net income. From the table below in determining the level of portfolio volatility, it can found that there is less variation by way of risk between the portfolio return. The reason for using the portfolio as a decisive venture plan is, as that holding portfolio of returns will have little variation of the expected return of dissimilar portfolios. The maximum expected return is 103.12% and the minimum one is -59.8%. Consequently, we can believe the expected returns are approximately dissimilar in different stock market and sector. Significance of Beta (β) in Ascertaining the stock volatility Beta (β) also known as coefficient of X variables using regression model, is an evaluation of the changes of the stock price in relation to the change in the whole market. It measures the systematic (non-diversifiable) risk of a company relative to the market index. In working out the beta, the company monthly historical data since January 2008 to 2014 are is considered significant (Anagnostopoulos, 2013). The exact time is selected to evade any theatrical variation in the company’s historical data for the reason that of Global Financial Crisis in 2008- 2009 might affect the performance of the stock return. A 51 months period of monthly data is believed to be adequate to provide a consistent result that will symbolize 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 employed as the market index depicts 500 best companies including BHP Billiton Company. Furthermore, accumulation index is being employed as a substitute of the non-accumulated for the reason that it considers both price growth and dividend income and assumes that dividends are reinvested back .The comprehensive monthly All Ordinaries Accumulated Index can be found in the Appendices. From the above data assessment, depict that the market returns is performing above those of the BHP Billiton as depicted by monthly returns. This consequently means that the business performance for the BHP Billiton is ultimate and as a result, the business is a having business risk is low at present due to robust measures taken by the business to improve its stock performance after the 2008 recession. The standard deviation of the individual company’s return is high as unlike the market standard deviation, which means that the stock price is volatile and thus investors deem investing in the shares of BHP Billiton should place more concern on having a portfolio of diversify asset in order to minimize risk of loss. A risk adverse investor must 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 depict a value of are 6.5% and 4.2% respectively. The anticipated return of the market and the BHP Billiton became 0.28 and 01.58 respectively with average risk premium of 22.5 and 95.7.the risk premium is low as compared to market risk, which means that the stock return for BHP Billiton is less volatile unlike those of the market. This points out that the higher standard deviation, the higher returns. When selecting the most advantageous portfolio in this report, a return with the lowest standard deviation must be considered. Consequently, portfolio with the lowest standard deviation/risk is the one we deem as the most advantageous. Conclusion It can therefore be concluded that the relation between risk and return is that of an inverse proportion because, the higher the risk of a return, the high the returns and as a result, to take advantage of on this and at the same time minimize the risk from the investment, an investor ought to think about holding a portfolio of securities. Component cost of capital is ultimate in ascertaining the worth of the firm because, cost of capital provides principle of calculating the cost of equity as well as cost of debt and as a result 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 experiential research portrays 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 therefore, it implies that, an investors must consider investing in a levered firm in view of the fact that there is low risk on investment thus investors will realize investment in form of profit within the short time. 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. This could be seen in the figure above in which depict that the monthly rerun is high with low volatility rate. However, with the consideration of rationale and limitation of this approach, the return depicted above for BHP Billiton fail to consider systematic risk and the measure of risk is also questionable. As a result, it is suggested to use CAPM analysis to decide portfolio investing. As shown from the above data analysis, the expected return for BHP is 0.2907% with a standard deviation of 6.4593. As shown in graph of portfolio combinations there is a positive linear relationship between risk of the portfolio and its expected return. After calculating with CAPM approach, the expected returns of BHP become 0.2907%. As the average risk premium is positive (6.5%).According to the CAPM theory, the relationship between beta and market sensitivity is positive. This indicates that a higher beta 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 is the one is considered as the optimal one. References Anagnostopoulos, K.a.M.G., 2013. ‘Using Multiobjective Algorithms to Solve the WEsDiscrete Mean-Variance Portfolio Selection’, International. Journal of Economics and Finance Questia Trusted online search., Vol. 2, No. 3. Annaert, J.C.D..M.J.K.a.H.W.V., 2005. The value of asset allocation advice: Evidence from the Economist’s quarterly portfolio. Journal of Banking andFinance, pp.pp. 661–680. Arnold, G., 2005. Corporate financial management. Financial Times/Prentice Hall Lt. bhpbillition, n.d. www.bhbbilliton.com. [Online] Available at: HYPERLINK "http://www.bhpbilliton.com/home/investors/news/Pages/Articles/Rio%20Tinto%20Offers%20No%20Longer%20In%20The%20Best%20Interests%20Of%20BHP%20Billiton%20Shareholders.aspx" http://www.bhpbilliton.com/home/investors/news/Pages/Articles/Rio%20Tinto%20Offers%20No%20Longer%20In%20The%20Best%20Interests%20Of%20BHP%20Billiton%20Shareholders.aspx [Accessed friday apirl 2015]. Bos, P.a.N.J., 1984. An empirical investigation of the possibility of stochastic systematic risk in the market model. Busines, vol 57, pp.pp. 43-41. Bowman, R., JASSA. Estimating the Market Risk Premium: The Difficulty with Historical Evidence and an Alternative Approach. 2001: JASSA. CFA, H., 2010. Security Valuation and Risk Analysis: Assessing Value in. coefficientl, B.D.I.b.o.e.t.b., 2003. vol 57, pp. 47-53.. Investment Analysts Journa, vol 57, pp.pp. 47-53. KEVIN, S., 2008. SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT. Pe˜naranda, F., 2007. Portfolio choice beyond the traditional approach. Forthcoming Revista de Econom´ıa Financiera. Sentana, E., 2003. Mean-Variance portfolio allocation with a value at risk constraint. Revista de Econom´ıa Financiera, 1, pp.4-14. Stimes, P.C., 2011. Equity Valuation, Risk and Investment: A Practitioner's. Read More