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ID: 2407831 • Letter: Y
Question
Your bank pays 4 Your bank pays 4 Your bank pays 4 Your bank pays 4 pp.n.), then otnel peers posts by Sunday of Week 1 (5 p.m.). Pèspond to two 1) Small companies have had the highest returns and the greatest volatility. However, in some industries, like the banking industry, the small firm is going the way of the dinosaurs. An extraordinarily large percentage of the banking business is controlled by large banks, especially now that the subprime crisis and longevity of the recession have caused many small banks to fail. What happens to the systematic risk within an industry that has become an oligopoly? How will a company's size affect unsystematic risk? The number of banks that are "too big to fail" has increased. What has that done to the discount rate appropriate for valuing banks? 2) Most of us have had the obnoxious experience of receiving stock tips from some clever spammers who manage to penetrate even the best spam filters. These stocks have been labeled "spam stocks." One site claims they could be a sign of a recovering economy. Some stocks are absolute scams, and others are legitimate, albeit extremely risky. However, if one had a large enough portfolio, unsystematic risk would theoretically be eliminated. How much volatility would a large portfolio of these spam stocks have compared to a portfolio of stocks from the NASDAQ? Post your response by Wednesday of Week 7 (5 p.m.), then respond to two other peers' posts by Sunday of Week 7 at (5 p.m.).Explanation / Answer
1. Systematic risk refers to the market risk. In an oligopoly, the market is shared by the few producers or sellers which means limited competition. Thus if anything happen to the large banks or any one, it poses more greater systematic risk i.e., company specific risk (unsystematic risks) will also add on to systematic risk. So it can be said that the systematic risk in an industry which has become an oligopoly is much higher compared to normal industry.
Company's size reflect two things : First is, company's standing poition in the market i.e., good competitive position in the marketplace means lesser unsystematic risk and operating business of the company which means if company has good operating business in diversified products, it reduces the unsystematic risk.
While valuing the company, the unsystematic risk has larger impact on valuing firm's value than systematic risk. If the number of banks too big too fail has increased, the industry will no longer be an oligopoly. Since the competition has increased which leads to greater systematic risk.
2. Volatility of large portfolio of spam stocks will be much higher compared to the portfolio of the stocks from NASDAQ.
As explained in the question, there are two risk associated with every stock which are systematic and unsystematic risk. Systematic risk (i.e., risk related to the market) is measured through Beta – which explains the volatility of the stock as compared with market. Beta of the market is equal to 1. Unsystematic risk is company specific risk which is calculated as total risk – systematic risk.
It is true that in a well diversified portfolio, unsystematic risks are eliminated / reduced to a large extent. Thus, volatility of portfolio of stocks from NASDOQ will be more or less equal to systematic risk only. But in case of portfolios having spam stocks which can either be legitimate or absolute spam stocks, unsystematic risk would such portfolio will also be considerably higher leading to much higher volatility.
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