Risk and Returns Assignment Example | Topics and Well Written Essays - 500 words

Risk and Returns - Assignment Example In order to diversify the risk, the assets are held together forming a portfolio. The sum of variance for the portfolio is almost lower than a single average weight of individual portfolio, therefore, minimizing the overall risk of investment (Rachev, 2005).  To clearly illustrate the model, the following capital structure for Wal-Mart stores for the year 2010 is used. Each component cost could be determined using various formulas. For instance, to determine the cost of debt using the Wall mart sore which has $1,000 PV (par value) zero coupon bond outstanding. Assuming that the bonds are currently trading at $ 385.54 with a 10 year maturity period and a tax rate of 40%, then the cost could be determined as follow. Finally the cost of equity would be determined using capital asset pricing model would be used to determine the cost of the components. Assuming that the risk free rate in the market is 4% and having been given the beta factor of 3 for bond and 0 for money market instruments. For a risk take investor, he will consider using debt which is much cheaper than common equity and preference stock. This is a risky investment, though the overall return will be much higher. The average weighted cost of capital will be much lesser i.e. 9% as par the computation above. On the hand if the investor considers using less debt which is cheaper and opt to use more equality and common stock as shown in the capital structure bellow; In conclusion, it is clear that risk is a universal factor in investment decision since no one can really stay away fro it. Though that is the case, risk can be reduced based on individually capability as well as their knowledge. For one to have successful portfolio management, then it will depend on the right mix of all assets and individual investor’s overall risk expectation. One of the key important choices which an investor has to consider is his where his risk tolerance lies. This