Risk of

A Single Asset
Presented by Ms. Kimbearly R. Cheng, MBA
 Topics Covered

RISK OF A SINGLE ASSET

TOPIC RISK MEASUREMENT

Risk of a Single Asset
 SCENARIO
ANALYSIS
A process of analyzing decisions by
considering alternative possible outcomes.
DESIGN
Designed to see the consequences of an action under
different sets of factors.

FEASIBILITY
Feasible enough to provide an accurate picture of the
outcomes.

SCENARIOS
Many scenario analyses use 3 scenarios: base
case, worst case, and best case. These can vary.
 TYPES OF SCENARIOS

BASE CASE WORST CASE BEST CASE

The average scenario, based on Considers the most serious or severe It is the ideal projected scenario and is
management assumptions. outcome that may happen in a given almost always put into action by
situation. management to achieve their objectives.
BENEFITS

FUTURE PLANNING PROACTIVE AVOIDING RISK PROJECTING

Gives investors a peek into Aoid or decrease potential
AND FAILURE RETURNS AND
the expected returns and losses that result from enables businesses or LOSSES
risks involved when planning uncontrollable factors by independent investors to makes use of tools to
for future investments. being aggressively preventive assess investment calculate the values or
during worst-case scenarios prospects. figures of potential gains or
by analyzing events and losses from an investment.
situations that may lead to
unfavorable outcomes.
DRAWBACKS

NEEDS HIGH SKILL UNFORESEEN CANNOT MODEL INDUCE

LEVEL OUTCOME ALL SCENARIOS COMPLACENCY
A demanding and time- Difficulty in forecasting may Very difficult to envision all One of the more dangerous
consuming process that occur in the future and the possible scenarios and traps of using them is that
requires high-level skills and actual outcome may be fully assign probabilities to them. they can induce a sense of
expertise. There's a dancger unexpected and not foreseen complacency, of having all
of having incorrect in the financial modeling. your bets covered.
assumptions and
correlations.
 Topics Covered
Define the issue and provide
assumptions

STEPS Gather data (historical and/or

probability)
Develop and evaluate scenarios (use a
template if necessary)

Plan accordingly
SAMPLE 1:
USING A SIMPLE
MODELLING TEMPLATE
 BEST CASE

WORST CASE

BASE/LIVE CASE

SAMPLE 2:
USING THE BASE-WORST-BEST SCENARIO TEMPLATE
SAMPLE 2:
USING THE BASE-WORST-BEST SCENARIO TEMPLATE (variation)
 THE Answers the "What if" questions about
the effect of changes in the value of

SENSITIVITY assumptions (usually to the profit).

Steps are similar to Scenario Analysis

ANALYSIS
 Initial assumptions
and values

BUT WHAT IF THINGS

GET WORSE BY 10%?
PROFIT IS MOST SENSITIVE TO THE SELLING PRICE PER UNIT!!!
 PROBABILITY
DISTRIBUTION

A bar chart is the simplest type of probability distribution; shows only a limited number of
outcomes and associated probabilities for a given event.

From the Norman Company example, bar charts for asset A’s and asset B’s returns
are as follows:
A continuous probability distribution is a probability distribution showing all the
possible outcomes and associated probabilities for a given event.

MODE! (Frequency or event happening)

In this case, asset D is riskier than Asset C!

 INVESTORS ARE GENERALLY RISK-
AVERSE
THE FINANCIAL FUNCTION THERE'S A NORMAL DISTRIBUTION
OF INVESTMENT RETURNS. SO WE
IS TO ALWAYS MAXIMIZE ONLY NEED THESE TO

YOUR RETURNS AND CHARACTERIZE INVESTMENT

PERFORMANCE:

MINIMIZE YOUR RISK. MEAN (MEASURES RETURN or

how much you'll earn)

THEREFORE, WE HAVE VARIANCE OR STANDARD

DEVIATION (MEASURES RISK or
THESE ASSUMPTIONS: how much an investment
deviates from the mean)
HISTORICAL DATA

SINGLE INVESTMENT
CALCULATING THE RETURN
(SAMPLE MEAN r̄ )

WHEREIN:
r = RETURN
n = NUMBER OF CASES
 THIS MEANS THAT BASED ON
HISTORICAL DATA, IF YOU MAKE
THIS PARTICULAR INVESTMENT
YOU ARE EXPECTED TO GET A
RETURN OF 2.75%
CALCULATING THE VARIANCE
(s2)

WHEREIN:
r = HISTORICAL RETURN
r̄ = MEAN RETURNS
n = NUMBER OF CASES
n - 1 = DEGREES OF
FREEDOM
 THE ABSOLUTE RISK OF THE INVESTMENT IS 0.0047.
**TAKE NOTE THAT WE DO NOT TURN THIS NUMBER INTO A PERCENTAGE
BECAUSE IT'S A SQUARED VARIABLE.

IF THE VALUE IS 0, THEN THERE IS ALMOST NO RISK IN THE INVESTMENT.

THE LARGER THE VARIANCE, THE GREATER THE OVERALL RISK EXPOSURE.
YOU CAN COMPARE THE VARIANCES OF ASSETS AND WHICHEVER HAS THE
LARGEST VARIANCE IS THE RISKIEST.
 CALCULATING THE
STANDARD DEVIATION
(The "s".)

WHEREIN:
s2 = VARIANCE
 THE STANDARD DEVIATION IS USED IF YOU REALLY WANT TO HAVE
A UNIT OF MEASURE FOR THE ASSET'S RISK.

MOST ANALYSTS USE THIS AS THE FINAL MEASURE FOR RISK OF A SINGLE ASSET.
 CALCULATING THE
COEFFICIENT OF VARIATION
(The CV)

WHEREIN:
s = STANDARD DEVIATION
r̄ = MEAN OF RETURNS


THIS MEANS THAT EVERY 1 UNIT OF RETURN CARRIES 2.5 UNITS OF RISK.

THE COEFFICIENT OF VARIATION (CV) MEASURES THE RISK PER UNIT OF RETURN

PROBABILITY DATA

SINGLE INVESTMENT
WHAT IF YOU DON'T
BELIEVE THAT CONSIDER THE POSSIBLE STATES OF THE

HISTORY DOESN'T ECONOMY, GOING FORWARD.

REPEAT ITSELF SO MAKE A JUDGMENT ON THE LIKELIHOOD

OF EACH STATE OCCURING.

HISTORICAL DATA IS THE SUM OF THESE PROBABILITY

VALUES SHOULD ALWAYS BE EQUAL
NOT A GOOD BASIS TO 1

FOR YOUR PROJECTIONS OF THE RATE OF RETURN

DEPENDS ON THE ANALYSIS OF OTHER
DECISION-MAKING? ASPECTS OF THE INVESTMENT, AS WELL
AS NUMBERS FROM OTHERS IN THE
INVESTMENT SERVICES INDUSTRY.
EXPECTED RETURN (ȓ)
THE PROBABILITY DISTRIBUTION MEAN

WHEREIN:
r = EXPECTED RETURN PER EVENT
P = PROBABILITY OF AN EVENT
HAPPENING
ALL THINGS CONSIDERED, THIS PARTICULAR INVESTMENT
HAS A PROBABILITY OF EARNING A 9.4% RETURN.
VARIANCE (σ2)
VARIANCE OF THE INVESTMENT

WHEREIN:
r = EXPECTED RETURN PER EVENT
ȓ = EXPECTED RETURN OF THE
INVESTMENT
P = PROBABILITY OF AN EVENT
HAPPENING
THE ABSOLUTE RISK OF THE INVESTMENT IS 0.0094

**TAKE NOTE THAT WE DO NOT TURN THIS NUMBER INTO A PERCENTAGE

BECAUSE IT'S A SQUARED VARIABLE.
 CALCULATING THE
STANDARD DEVIATION
(The "σ".)

WHEREIN:
σ = VARIANCE
THE RISK OF THE INVESTMENT IS 9.70%
 CALCULATING THE
COEFFICIENT OF VARIATION
(The CV)

WHEREIN:
σ = STANDARD DEVIATION
ȓ = EXPECTED RETURNS


THIS MEANS THAT EVERY 1 UNIT OF RETURN CARRIES 1.03 UNITS OF RISK.

THE COEFFICIENT OF VARIATION (CV) MEASURES THE RISK PER UNIT OF RETURN

ENDE