Understanding relationship between risk and cost of capital

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Reference no: EM131182095

The topics of the chapters this week are learning to measure risk and understanding the relationship between risk and the cost of capital. The cost of capital for a project is the rate of return that shareholders could expect to earn if they invested in equally risky securities. One way to estimate the cost of capital is to find securities that have the same risk as the project and then estimate the expected rate of return on these securities. We will also look at historical rates of return earned from past investments, especially concentrating on those earned from risky rather than safe securities. Next, we will learn how to measure the risk of a portfolio and study past history to find out how risky it is to invest in the stock market. Finally, we will look at the concept of diversification which means not "putting all yours eggs in one basket." Lastly, we will distinguish between the risk that can be eliminated by diversifying and the risk that cannot be eliminated. Diversification is a strategy designed to reduce risk by spreading the portfolio across many investments. Selling umbrellas is a risky business; you would make plenty when it rains but could lose your shirt in a heat wave. Selling ice cream is no safer; you do well in the heat wave, but business is poor in the rain. However, if you invested in both businesses, you could make an average level of profit come rain or shine. This week's assignment is to watch the video about the Power of Diversification located in the Week 3 Video Folder. Next, build a personal portfolio of 7-10 firms either equally invested or investment spread unevenly. List the firms you have chosen and the reason for your choices and how diversification played a role in your choices. You may need to review the Power Point slides located in the Course Document section and also the chapters in your book. 250 post required.

Reference no: EM131182095

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