answer the following. about Discussion: Risk and Return Considerations. -Describ
ID: 2790881 • Letter: A
Question
answer the following. about Discussion: Risk and Return Considerations.
-Describe how the variance terms are effectively diversified away in a large portfolio ?
- How would a portfolio with a large percentage (i.e., 25 – 40%) of Kimberly-Clark shares, need to be protected or adjusted in terms of accounting for portfolio risk?
- Additionally, would shares of Kimberly-Clark within a portfolio be considered a defensive stock?
- How is Kimberly-Clark’s distribution policy impacting the company and is it increasing or decreasing its EPS and dividends-per-share?
Explanation / Answer
Regardless of the allocation or diversity of a portfolio there will always be some type of risk. The level of risk associated with a particular investment or asset class typically correlates with the level of return the investment might achieve. “Historically stocks have enjoyed the most robust average annual returns over the long term (just over 10% a year), followed by corporate bonds (around 6%), treasury bonds (5.5 %) and cash/cash equivalent such as short-term treasury bills (3.5%). The tradeoff is that with this higher return comes greater risk as an asset class, stocks are riskier than corporate bonds, and corporate bonds are riskier than treasury bonds or bank savings products” .
There’s a small part of the portfolio that cannot be rid of risk and that’s called the systematic portion of risk. The variance risks are what we already mentioned above: systematic (market) risk and unsystematic (diversifiable) risk which are random events that can affect either a single security or a small group of securities. Covariance risks work a little differently and cannot be diversified away. A covariance can be calculated by taking the historical returns as both independent and dependent variables and individual pricing. By taking this data- it is calculating the daily return and subtracting the mean for the asset and multiplying these values and then dividing the amount of periods.
By using a negative covariance we will see an overall reduction of risk within the portfolio. “Diversifiable risk cannot significantly be reduced beyond including 25 different stocks in a portfolio. However adding more assets with negative covariance means that the risk drops more quickly” .
The diversification of Kimberly-Clark and the places they’ve invested will always be high-demand items and because of their long-term debt that’s driven their stock price up. The company has taken strides to expand their markets and continuously increase their revenue. Defensive stock takes precedence in always providing a return or dividend regardless of the volatility in the market. My personal portfolio is moderately aggressive with some conservativeness and I would consider investing in KMB.
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