Introduction
The objective of this assignment is to give us understanding of overall view in the subject of business finance with the topic that we are discussing about is risk budgeting. The article is extracted from The Edge magazine (Title: Are Fees Falling?), issue #33, page 55, May 2004. This article is showing us what is risk budgeting and how it helps investors investing in the portfolio.
It gives investors to focus on the degree of risk that an investor need take for their return. Theoretically, high risk investment has higher return and low risk investment has lower return. This is because with higher risk of investment, investors need to bear higher risk of losses and therefore they require higher return and vice versa. Required rate of return is the minimum rate of return on a common stock that a stockholder considers acceptable (Brigham and Houston).
Summary
What’s risk budgeting?
A core principle of the modern portfolio theory is that the higher the investment return, the greater the risk. It is possible to construct a portfolio that can maximise the highest possible return at the lowest possible risk. Indeed, studies have indicated that 90% of the difference in returns among portfolio can be managed by allocating the portfolio according to one’s risk tolerance and need for returns. The remaining 10% of the risk can be addressed by risk budgeting.
Risk budgeting is a tool to track risk per unit of reward. It can be a useful tool for individual investors to manage their expectations effectively. The process of risk budgeting helps to determine if you are adequately rewarded for the risks you are taking. When a port ...