Question

Put your team's answer to each question on a separate page. Include diagrams and or mathematical expressions where appropriate. (Neat hand-drawn diagrams and hand-written mathematical expressions are acceptable.) 1. (Answer each part in 2-5 sentences.) Amazon listed the following risk factors in Item 1A. of its 2017 10-K. State which of the following risks are mainly unique risks and which are mainly market risks Explain your reasoning Our Supplier Relationships Subject Us to Risks: We lack long-term arrangements with most of our suppliers so if suppliers stop selling to us, it may damage our operating results a. b. We Have Foreign Exchange Risk: When revenues from our international websites are converted to dollars, our profitability could be harmed We Could Be Harmed by Data Loss or Other Security Breaches: Our sales are web-based so data loss or security breach could adversely affect our operating results and profitability c. d. We Could Be Subject to Additional Sales Tax: States and foreign jurisdictions impose taxes with little or no warning; failure to comply with these laws could result in significant penalties that could damage our profitability We Face Significant Inventory Risk: Seasonality of some products, rapidly changing consumer tastes, and spoilage may cause us to be understocked or overstocked in some products, hurting our operating results and profitability e. 2. (Answer in 4-8 sentences.) Portfolio S is a three-stock portfolio. Portfolio L is a 100-stock portfolio Explain carefully why Portfolio L has a smaller return variance, that is, why ?L2 < ?S2. (Potentially helpful information: in the current environment an average stock has an expected (annual) return of around .08 (8%), a return standard deviation of .40 (40%), and a return variance of .16. Depending on its construction, a portfolio with a large number of stocks might have a return standard deviation of .20 and a return variance of.04) 3. (Answer in 4-8 sentences.) Historically, a portfolio composed of the stocks of the 500 largest US companies has had a return standard deviation (OR) of about .21 (21%) whereas a portfolio composed of the stocks of the 2,000 smallest companies traded on the New York Stock Exchange has had a return standard deviation of .33 (33%). Why are the risk measures for these two portfolios so different? Defend your answer with the strongest arguments you can marshal

Answer 1

1. Unique risk is exposure to a particular company, and is sometimes referred to as firm-specific risk.

Market risk, on the other hand, is the risk of losses due to factors that affect the overall performance of the markets in which he or she is involved.

Let us apply the above definitions and try to answer the various statements:

1. The absence of long term arrangements with suppliers is a unique risk since this is not affecting the market as a whole. Other companies might have hedged themselves by having such long term arrangements and hence, this risk is Amazon specific,
2. Amazon, like almost all it’s global counterparts is subjected to this risk. All major global firms, having operations in various countries are subject to this risk of currency fluctuation. Since this risk is not Amazon specific, it is a market risk.
3. Since Amazon is a web based portal, it is susceptible to data breaches. Since not every organization has a business model like that of Amazon, the susceptibility to Data breach for Amazon is unique and hence, it is a unique risk.
4. Levy of additional sales tax is not specific to Amazon and hence would not be a unique risk. Since the entire gamut of companies gets impacted by such levies, it is a market risk.
5. Since Amazon has a business model which requires stocking of seasonal products which may ultimately go out of taste or fashion, it is always susceptible to the risk of them becoming obsolete. This risk is not prevalent throughout the market and hence is a unique risk.

1. Generally, as the number of assets in a portfolio increases, the risk of the portfolio decreases. Diversification relies on a loose relationship between the returns of the assets in the portfolio. For example, among a group of ten stocks, one company might make a poor business decision, which results in a decrease in that stock's price.
2. There are four primary aspects of small-cap stocks that make them potentially riskier than large-cap stocks thereby leading to higher standard deviation. Small-cap firms generally have less access to capital and, overall, not as many financial resources. This makes it difficult for smaller companies to obtain necessary financing to bridge gaps in cash flow, fund new market growth pursuits or undertake large capital expenditures. Small-cap stocks have a lower trading liquidity. For investors, this means enough shares at the right price may be unavailable when they wish to buy, or at times, it may be difficult to sell shares quickly at favorable prices. Further, such stocks simply a lack of operational history and the potential for unproven business models to prove faulty.