PowerPoint presentation

Derius Hopkins

Purdue University Global

FI499 Bachelor’s Capstone in Finance

Dr. Ernesto Escobedo

5-22-23

Amazon

Examine three differences between the risk and risk aversion of Amazon.

Investor and manager decisions are influenced by two fundamental financial concepts: risk and risk aversion. Risk aversion is the degree of preference for a particular outcome over a risky one. Risk is the uncertainty or variability of returns on an investment or project. In this report, we will look at three contrasts between the endless hazard avoidance of Amazon, one of the biggest online business stages on the planet. We will also discuss the effects of covariance and correlation on Amazon's risk and the three distinctions between systematic and unsystematic risk. Last, we'll talk about Amazon's enterprise risk management (ERM) and how it helps the company reduce risks. Our analysis will be supported by financial data from Amazon's annual reports, stock prices, and market indices.

The first distinction between risk aversion and risk is that risk aversion is a subjective attitude that varies between individuals and organizations. In contrast, risk is an objective measure that can be quantified. We can, for instance, calculate Amazon's stock's beta or standard deviation, which indicates the extent to which the stock price deviates from its mean or moves with the market. As per Yippee Money (2023), the standard deviation of Amazon's everyday returns as far back as the year was 0.0195, and its beta was 1.14 as of May 23, 2023. These numbers propose that Amazon's stock is moderately unpredictable and delicate to showcase developments. On the other hand, risk aversion is a personality trait that indicates how much an investor or manager despises taking risks. Because they are willing to invest in a high-risk, high-return company that reinvests the majority of its earnings into growth and innovation rather than paying dividends, Amazon's shareholders are less risk-averse than average investors.

Risk has an impact on Amazon's expected return and cost of capital. In contrast, risk aversion impacts Amazon's required return and valuation, the second distinction between risk and risk aversion. The capital asset pricing model (CAPM) states that an asset's expected return is the sum of the asset's risk-free rate, market risk premium, and risk premium determined by the asset's beta. The minimum return an investor or lender anticipates receiving from lending money to a business is the cost of capital. The CAPM or other approaches, such as the weighted average cost of capital (WACC), can be utilized to estimate the cost of capital. According to these models, Amazon's cost of capital and expected return are higher at higher risk. For instance, we can estimate Amazon's expected return on stock at 11.16 percent and its cost of equity at 11.16 percent using the CAPM with a risk-free rate of 2 percent, a market return of 10 percent, and a beta of 1.14.

Similarly, we can estimate that Amazon's cost of capital is 8.64 percent using the WACC with a debt-to-equity ratio of 0.4, a cost of debt of 3%, and a tax rate of 21%.

On the other hand, risk aversion affects Amazon's required return and valuation by influencing the market's demand and supply of its securities. The valuation is the present value of the future cash flows generated by an asset, while the required return is the minimum return that an investor requires to invest in an asset. Risk aversion leads to a higher required return and a lower Amazon valuation. For instance, if financial backers become riskier because of a monetary slump or a negative news occasion, they might request a better yield to put resources into Amazon's stock or securities, bringing down their costs and valuation.

The third distinction between endless hazard avoidance of Amazon is that chance can be enhanced or supported, while hazard avoidance can't be killed or decreased. Broadening is the most common way of joining various resources or undertakings with low or negative connections, diminishing the general risk of a portfolio or a firm. According to Yahoo Finance, hedging is using derivatives or other instruments to offset or reduce exposure to a particular source of risk, such as changes in interest rates or currency fluctuations. By expanding into diverse markets, products, or services with distinct demand patterns or growth prospects, for instance, Amazon can diversify its business risk. Amazon can likewise fence its monetary risk by utilizing fates, choices, trades, or different agreements to secure positive trade rates or loan fees for its worldwide tasks or obligation commitments. However, diversification and hedging cannot eliminate all forms of risk, particularly systematic risk, which is the threat posed by macroeconomic factors such as inflation, recession, or war on all assets or businesses in the market. Systematic risk cannot be diversified because it is correlated with all other risk sources. In addition, diversification and hedging cannot alter investors' or managers' risk aversion based on their preferences, beliefs, and experiences. Risk aversion can change only by providing information, education, incentives, or guarantees that may alter their perception or attitude toward risk.

Examine three differences between systematic and unsystematic risk for Amazon.

Methodical and unsystematic dangers are two kinds of dangers that influence resources or firms in various ways. Because it is influenced by macroeconomic factors like inflation, recession, or war, systemic risk is also referred to as market risk or non-diversifiable risk. Unsystematic risk is called explicit or diversifiable risk since it influences a particular resource or firm because of microeconomic factors like item quality, consumer loyalty, or the executive's execution. For Amazon, one of the world's largest e-commerce platforms, we will examine three distinctions between systematic and unsystematic risk in this report. Our analysis will be supported by financial data from Amazon's annual reports, stock prices, and market indices.

The primary distinction between system and unsystematic risk for Amazon is that methodical risk is estimated by beta, while unsystematic risk is estimated by standard deviation. The ratio of an asset's return to the market return, or beta, measures the asset's exposure to systematic risk. The asset's total risk, which includes systematic and unsystematic components, is reflected by the asset's standard deviation, or deviation from the mean. For instance, Amazon's stock's beta was 1.14 as of May 23, 2023, according to Yahoo Finance (2023). This indicates that Amazon's stock typically moves 14% more than the market on average.

The second difference between Amazon's systematic and unsystematic risks is that Amazon's expected return and cost of capital are affected by systematic risk, whereas unsystematic risk does not. As per the capital resource valuing model (CAPM), the normal profit from a resource is equivalent to the risk-free rate and a risk premium that relies upon the resource's beta and the market risk premium. The minimum return an investor or lender anticipates receiving from lending money to a business is the cost of capital. The CAPM or other approaches, such as the weighted average cost of capital (WACC), can be utilized to estimate the cost of capital. According to these models, Amazon's cost of capital and expected return are higher with higher systematic risk. For instance, we can estimate Amazon's expected return on stock at 11.16 percent and its cost of equity at 11.16 percent using the CAPM with a risk-free rate of 2 percent, a market return of 10 percent, and a beta of 1.14.

One can estimate that Amazon's cost of capital is 8.64 percent using the WACC with a debt-to-equity ratio of 0.4, a cost of debt of 3%, and a tax rate of 21%. Then again, an unsystematic risk doesn't influence Amazon’s normal return or cost of capital since financial backers or administrators tend to enhance it away. Unsystematic risk influences the genuine profit from a resource. For Amazon, the third distinction between systematic and unsystematic risk is that unsystematic risk is measured by standard deviation while systematic risk is measured by beta. Beta is a proportion of how delicate a resource's return is to the market return (yippee finance, 2023). If an asset has a beta of 1, it moves in line with the market; if it has a beta greater than 1, it is more volatile than the market; and if it has a beta lower than 1, it is less volatile than the market. Standard deviation is a proportion of how scattered a resource's return is around its mean. A better quality deviation implies that the resource has greater changeability and vulnerability in its return.

Covariance and correlation and how they affect the risk of Amazon.

Two statistical concepts that measure how two variables interact are covariance and correlation. The measure of how much two variables change together about their means is known as covariance. A zero covariance indicates that the two variables are independent, while a positive covariance indicates that they tend to move in the same direction. A negative covariance indicates that they tend to move in opposite directions. Connection is a proportion of serious areas of strength for the straight connection between two factors. The connection goes from - 1 to 1, where the - 1 method is an ideal negative straight relationship, the 1 method is an ideal positive direct relationship, and the 0 methods have no direct relationship.

Amazon's risk is influenced in different ways by covariance and correlation. Covariance influences the efficient risk of Amazon since it decides the amount Amazon's return is affected by the market return. A higher covariance implies that Amazon's return is more presented to showcase vacillations, which expands its orderly risk and beta. Relationship influences the unsystematic risk of Amazon since it decides the amount Amazon's return is impacted by different elements that are well defined for Amazon or its industry. A higher correlation indicates that these factors have a greater impact on Amazon's return, which raises its unsystematic risk and standard deviation.

Explain enterprise risk management (ERM)

According to Investopedia, n.d., enterprise risk management (ERM) is a methodology that approaches risk management strategically from the perspective of the entire business or organization. A hierarchical system plans to recognize, evaluate, and prepare for possible misfortunes, risks, perils, and different possibilities for the hurt that might disrupt an association's tasks and goals and lead to misfortunes.

Amazon, the largest online retailer in the world, is one of the businesses that uses ERM. Operational, financial, security, compliance, legal, and reputational risks are just a few of Amazon's business risks (Amazon, 2021). Amazon uses ERM practices that align with its vision, mission, values, and objectives to manage these risks effectively. Using financial data to explain its risk exposures and mitigation strategies to stakeholders is one way Amazon uses ERM. For instance, the following details about Amazon's ERM were made public in the company's 2020 annual report:

1. The company's risk management process entails figuring out and prioritizing the most significant risks that could affect the performance of the business, its reputation, or its financial situation.

2. The company's senior management and board of directors regularly review and supervise the risk management activities.

3. The company's audit committee works with the board of directors to monitor its internal control over financial reporting and ensure it complies with all applicable laws and regulations.

4. The company's compensation committee works with the board of directors to monitor the compensation policies and practices that could affect the company's willingness to take risks.

5. The company's succession planning and talent development programs, which may impact the company's capacity to manage risks effectively, are overseen by the board of directors with assistance from the leadership development and compensation committee.

6. The organization's selecting and corporate administration advisory group helps the top managerial staff administer its corporate administration strategies and practices that influence its risk culture and responsibility.

By explaining its ERM with financial data, Amazon demonstrates its transparency, accountability, and responsibility to shareholders, customers, employees, regulators, and other stakeholders. It also shows its obligation to accomplish its essential targets while properly dealing with its dangers.

References

Investopedia. (n.d.). Enterprise risk management (ERM). Retrieved from https://www.investopedia.com/terms/e/enterprise-risk-management.asp

Amazon. (2021). Amazon 2020 annual report. Retrieved from https://ir.aboutamazon.com/static-files/6a0b3cda-6e83-4c5b-b94f-888cfa4e9a74

Yahoo Finance. (2023, May 23). Amazon.com, Inc. (AMZN). Retrieved from https://finance.yahoo.com/quote/AMZN/