12

BUSINESS FINANCE
Second Quarter

Week 3 and 4

LEARNING ACTIVITY SHEETS

 BUSINESS FINANCE
Name of Learner:
Section: Grade Level:
Score:

LEARNING ACTIVITY SHEET

WAYS TO MINIMIZE OR REDUCE INVESTMENT RISKS

Background Information for Learners

Risk management is the process of identification, analysis and acceptance or mitigation of

uncertainty in investment decisions. Risk is inseparable from return in the investment world.
(https://www.investopedia.com/terms/r/riskmanagement.asp). Putting your money into an investment
is always accompanied by a risk.

Brown and Reilly (2014) identified the major sources of risks as follows:

1. Business risk
2. Financial risk
3. Liquidity risk
4. Exchange rate risk
5. Country risk

Business risk is related to the nature of the company’s products and operating strategy.
Companies with stable sources of sales and earnings have relatively low business risk.

Financial risk refers to the risk created by the choice of capital structure—the
financing mix of the issuing company. A company usually funds its operation through debt
and equity financing. As the debt portion increases, financial risk increases.

Liquidity risk is the uncertainty that an investment can be converted to cash at a

known price. The existence of exchange facilities eases in liquidating an investment. If there
is no ready market for the investment, it is considered illiquid and a higher liquidity premium
is required by investors. The presence of many ready buyers and sellers reduces liquidity risk.

Exchange rate risk exists if the investment is denominated in another currency

different from that of the local currency of the investor. An additional uncertainty exists if the
investor needs to liquidate the foreign currency-denominated investment and convert it to
Philippine peso, for example.

Country risk is associated with political and economic uncertainty of a particular

business environment. You can only entice investors to invest in countries with political
stability if a higher rate of return is expected.

2| Note: Practice Personal Hygiene protocols at all times

 With these sources of risks that an investor may encounter for his investment, here are
the steps on how to minimize or reduce risk on your investment.

STEPS TO MINIMIZE OR REDUCE INVESTMENT RISK

Source:https://www.clearrisk.com/risk-management-blog/bid/47395/the-risk-management-
process-in-5-steps

1. Identify Risks. The four main risk categories of risk are hazard risks, such as fires or
injuries; operational risks, including turnover and supplier failure; financial risks,
such as economic recession; and strategic risks, which include new competitors and
brand reputation. Being able to identify what types of risk you have is vital to the risk
management process.

An organization can identify their risks through experience and internal

history, consulting with industry professionals, and external research. They may also
try interviews or group brainstorming.

2. Measure Risk. A risk map is a visual tool that details which risks are frequent and
which are severe (and thus require the most resources). This will help you identify
which are very unlikely or would have low impact, and which are very likely and
would have a significant impact.
Knowing the frequency and severity of your risks will show you where to
spend your time and money, and allow your team to prioritize their resources.

3. Examine Solutions. Organizations usually have the options to accept, avoid, control,
or transfer a risk.

Accepting the risk means deciding that some risks are inherent in doing
business and that the benefits of an activity outweigh the potential risks.
 To avoid a risk, the organization simply has to not participate in that activity.

Risk control involves prevention (reducing the likelihood that the risk will
occur) or mitigation, which is reducing the impact it will have if it does occur.

Risk transfer involves giving responsibility for any negative outcomes to

another party, as in the case when an organization purchases insurance.

4. Implement Solution. Once all reasonable potential solutions are listed, pick the one
that is most likely to achieve desired outcomes.

Find the needed resources, such as personnel and funding, and get the
necessary buy-in. Senior management will likely have to approve the plan, and team
m embers will have to be informed and trained if necessary.

Set up a formal process to implement the solution logically and consistently

across the organization, and encourage employees every step of the way.

5. Monitor Result. Risk management is a process, not a project that can be “finished”
and then forgotten about. The organization, its environment, and its risks are
constantly changing, so the process should be consistently revisited.
Determine whether the initiatives are effective and whether changes or
updates are required. Sometimes, the team may have to start over with a new process
if the implemented strategy is not effective.

Risk Measure and Risk Reduction

Risk Measure – Single asset

A basic risk measure for a single asset is the variance and standard deviation (square root
of the variance) of returns. The variance ( is computed as follows:
n
 
[Rt – Rmean]2
t=n n
Where:
Rt = Return for a Particular Period
Rmean = Average return
n = Number of Periods

Computing the variance involves the following steps:

1. Get the mean.

2. Get the difference of each return and the mean.
3. Get the squared difference.
4. Add the squared difference.
5. Divide by the number of periods.
 For example, the following returns pertain to the years indicated for stock A:

Stock A
2011 13.25%
2012 16.25%
2013 13.80%
2014 20.70%
2015 11.20%

Using the steps above:

1. Get the mean—average return for the 5-year period.

Rmean = 75.20% / 5 years
= 15.04%

2. Get the difference of each return and the mean.

Stock A In percentage In decimal (In
(In percentage) decimal)
2011 13.25%-15.04% -1.79% -0.0179
2012 16.25%-15.04% 1.21% 0.0121
2013 13.80%-15.04% -1.24% -0.0124
2014 20.70%-15.04% 5.66% 0.0566
2015 11.20%-15.04% -3.84% -0.0384
3. Get the squared difference.

Stock A Difference (In Difference (In Squared

percentage) decimal) Difference
2011 13.25%-15.04% -1.79% -0.0179 0.00032041
2012 16.25%-15.04% 1.21% 0.0121 0.00014641
2013 13.80%-15.04% -1.24% -0.0124 0.00015376
2014 20.70%-15.04% 5.66% 0.0566 0.00320356
2015 11.20%-15.04% -3.84% -0.0384 0.00147456

4. Add the squared difference.

Sum = 0.00529870
5. Divide by the number of periods.
Variance = 0.00529870 / 5 years = 0.00105974
The standard deviation is equal to the square root of the variance:
  he standard deviation of the returns of Stock A is equal to 3.26%. The
greater the standard deviation of the returns, the greater is the risk of the single a sset.
Risk-Return Measure
Assets should be compared based on both risk and return. The coefficient of variation
is a simple risk-return measure to compare various assets. It is computed by dividing the
standard deviation of returns by the mean return.
 Coefficient of variation =   Rmean
Using our Stock A example, the coefficient of variation is equal to:
Coefficient of variation = 0.0326 / 0.1504 = 0.21676
Based on this simple measure, investors should prefer assets with a low coefficient of
variation.
Risk Reduction
From a portfolio perspective, risk, as measured by the portfolio variance or standard
deviation, can be reduced by combining assets whose returns do not move in the same
direction or at least do not move perfectly together.
This will accomplish the same objective of minimizing risk for a given level of
return. It is then the objective of the investor to look for these assets, whose returns are not
correlated, less correlated, or better yet, negatively correlated.
It is recommended that an investor should not pull out his money in a single asset and
diversify his portfolio into various assets associated with differing industries and businesses.
As they say, “Do not put all your eggs in one basket.”

LEARNING COMPETENCY
Measure and list ways to minimize or reduce investment risks in simple case problems,
Quarter 2, Week 1-2) ABM_BF12-IVm-n-25

Exercise 1. Directions. Write A if the statement or phrase is related to a, write B if the

statement or phrase is related to b, write C if the statement or phrase is related to both a and b,
and write D if the statement or phrase is not related to both a and b.

1. It is used to measure risk on investment.

a. volatility
b. diversification
2. Risk management process
a. identification of risk
b. solution implementation
3. Liquidity risk
a. political and economic uncertainty
b. choice of capital structure
4. Hazard risk
a. Tsunami
b. Theft
5. Strategic risk
a. Trade mark
b. Franchise
6. Risk transfer
a. Buying of insurance policy
 b. Selling of equipment with salvage value of 50,000.
7. Risk control
a. Installation of CCTV to the whole working area
b. Installation of Biometric machine
8. Standard deviation
a. systematic investment
b. non-systematic investment
9. A risk management technique that combines a wide variety of investments within
a portfolio to reduce risk.
a. standard deviation
b. diversification
10. A risk management step which determine changes and updates are required
a. identify risk
b. measure risk

Exercise 2. Directions: Write A if the statement is correct, write B if the statement is

incorrect. Write your answer in the space provided for you.
1. The lower the standard deviation is, the lower is the risk of the single asset
2. Volatility considered systematic investment and non-systematic investment.
3. Return on investment should be considered in analyzing risk.
4. Volatility is often calculated using variance and standard deviation
5. The standard deviation is equal to the square root of the variance.
6. Assets should be compared based on both risk and return.
7. Liquidity risk exists if the investment is denominated in another currency different
from that of the local currency of the investor.
8. Companies with stable sources of sales and earnings have relatively low business risk.
9. A company usually funds its operation through debt and equity financing.
10. Risk can be defined as the uncertainty of returns.
Answer Key

Exercise 1
1. C
2. C
3. D
4. A
5. C
6. C
7. C
8. C
9. B
10. D

Exercise 2
1. A
2. A
3. A
4. A
5. A
6. A
7. B
8. A
9. A
10. A