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Financial Theory And Corporate Policy Essay

2126 words - 9 pages

Introduction
‘’Investors are risk averse’’ a statement which compounds the reasons why this analysis is carried out. An investor who is willing to accept risk would only do so if the returns on the investment are sufficient enough to compensate for the extra risk incurred. The report is aimed at making a brief analysis on the risk and performance on the returns of two FTSE 100 companies namely Chevron Corporation and BP Plc. Usually investors who are risk averse would either be interested in an efficient way to manage their portfolio (assets), that is to minimize the risk for a given return or maximize the rate of returns for a given level of risk. These portfolios (assets) which dominate ...view middle of the document...

The exploration and production segment is the upstream operation which is responsible for the exploration of oil and gas, field developments, production, intermediate transportation, storage and processing. The main profit is created by marketing and trading natural gas, including liquefied natural gas, power and natural gas liquids in this segment. The refining and market part of the company focuses on fuels, lubricants and petrochemicals. Downstream operation include refining of the crude oil, manufacturing, and marketing of the petrol, transportation, supply to customers and finally the trading of the crude oil, petroleum, petrochemicals products to wholesale and retail customers.
On the other hand, Chevron Corporation being an American multi-national energy corporation headquartered in San Ramon, California is involved in nearly all aspects of the oil, gas and geothermal energy industries which also include the exploration, production, refining of crude oil and natural gas, marketing and transportation of fuels and lubricants, Petrochemical products manufacturing and sales, power generation and the production of geothermal energy. The rankings in 2013 on Chevron moved from being the world’s 4th Energy Company (2012) based on market capitalization (what was the amount in 2012 $xxx Bn) to 2nd with a market capitalization of $240.2 bn. Chevron also reported Sales and other Operating Revenues of $231bn return on capital employed of 18.7 percent and a Return on stockholder’s equity of 20.3 percent for the year 2013.
RISK ANALYSIS
CAPM Beta
Beta is a measure of the diversified risk of a security (portfolio) in comparison to the market in its entirety. Beta is used in the capital asset pricing model (CAPM), a model which calculates the expected return of an asset based on its beta and expected market returns. The CAPM gives the relationship between expected return and risk, this relationship is stated by the following formula (Hillier, 2013).

R_a=R_f+"β (" R_m "-" R_f ")"
Where:
R_a is expected return
R_f is risk free rate
"β" is beta coefficient
R_m is expected market return
"(" R_m "-" R_f ")" is Equity market premium

According to the formula of CAPM, beta is the measurement of a stock’s risk. It measures a stock’s volatility in relation to the market. Without considering the risk free rate, the equation will give a straight line, with "β" being the slope of that line (Tofallis, 2008). So the beta coefficient can be explained as ratio of expected return and market return. The graph of the equation would not be a straight line, because the risk free rate is always changing over a period of time. However, the conclusion of beta will be always right: the higher beta means higher returns but more risk and vice versa. The market always has a beta of one.
The formula used to calculate beta is:
β=(Cov(R_a,R_m))/(Var(R_m))
Where: “Cov ((R_a,R_m)” and “Var( R_m)” are the covariance and variance respectively.

Beta is clear and easy to measure...

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