UCLA ECON 103 - Chap013 (1) (7 pages)

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Chap013 (1)



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Chap013 (1)

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Pages:
7
School:
University of California, Los Angeles
Course:
Econ 103 - Introduction to Econometrics

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Chapter 13 Risk Analysis Solutions to Questions Chapter 13 Risk Analysis Question 13 1 What is meant by partitioning the internal rate of return Why is this procedure meaningful To illustrate what is meant by partitioning the IRR remember that the IRR is made up of two components of cash flow 1 cash flow from operations and 2 cash flow from the sale of the investment Partitioning is done to obtain some idea of the relative weights of these components of return and to get an idea of the timing of the receipt of the largest portion of that return Partitioning is meaningful because it helps the investor to determine how much of the return is from annual operating cash flow and how much is from the projected resale cash flow Operating cash flow is generally more certain than projected resale cash flow Therefore the greater the proportion of resale cash flow versus operating cash flow the greater the risk facing the investor This could be useful in comparing multiple investments Question 13 2 What is a risk premium Why does such a premium exist between interest rates on mortgages and rates of return earned on equity invested in real estate A risk premium is a higher expected rate of return paid to an investor as compensation for incurring additional risk on a higher risk investment In general investors are considered risk averse and must be compensated more for the higher risk of some investments This premium exists between mortgage interest rates and returns on equity invested in real estate because the equity investor is assuming more risk than the mortgage lender The lender assumes less risk because a lender would have first claim on the property should there be a default If this were not the case the investor would be better off lending on real estate than investing in it Question 13 3 What are some of the types of risk that should be considered when analyzing real estate and other categories of investment Business Risk Financial Risk Liquidity Risk Inflation Risk



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