HB 311: FINAL EXAM
28 Cards in this Set
| Front | Back |
|---|---|
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Relationship between risk and return
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-depends on tolerance for risk
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Required returns
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The return on an investment required by an investor given market interest rates and the investment's risk
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Calculate required returns
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risk-free rate of return + (market risk+company unique risk)
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Rf
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Risk Free Rate of Return
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Portfolio theory
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-Investing in more than one security to reduce risk.
-If two stocks are perfectly positively correlated, diversification has no effect on risk.
-If two stocks are perfectly negatively correlated, the portfolio is perfectly diversified.
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Systematic risk
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(Market risk)
-Nondiversifiable
-Cannot be diversified away
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Unsystematic risk
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(Company-unique risk)
-Diversifiable
-Can be reduced through diversification
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Why do we have Beta?
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We need to be able to measure market risk
-a measure of the "sensitivity" of an individual stock's returns to changes in the market.
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The market's beta is _____.
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Beta = 1 (average market risk)
Beta > 1 (more volatile)
Beta < 1 (less volatile)
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Capital asset prcing model (CAPM)
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This linear relationship between risk and required return
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Do some firms have more market risk than others?
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Yes
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Interest rate changes affect all firms, but which would be more affected:
a) Retail food chain
b) Commercial bank
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B
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To measure risk by using _____ for overall risk, and _____ for market risk.
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-standard deviation
-beta
|
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We know how to reduce overall risk to only market risk through _______
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diversification
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Calculate expected return
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E(k) = (k1)(Pk1) + (k2)(Pk2) + (k3)(Pk3)
|
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Calculate standard deviation as a meaure of risk
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((k1-Ek)) 2xPk1
+ ((k2-ek)) 2*Pk2
+ ((k3-Ek)) 2*Pk3
= ###
THEN TAKE SD
|
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Simple return calculations
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(P2-P1)/P1 = %
|
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Calculate beta of portfolio
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(# stock/total stock)*#betas
+
(# stock/total stock)*#betas
|
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Required rate of return using CAPM
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ke=Rf+(km-rf)Beta
|
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What is capital budgeting
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Expenditure on fixed assets that are large in nature and yield returns beyond one year
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Risk profiles of different capital budgeting projects
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-Stand-Alone and Mutually Exclusive Projects
-Project Cash Flows
-The Cost of Capital
|
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Advantages of using the payback method
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-It's quick and easy to apply
-Serves as a rough screening device
|
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Disadvantages of using the payback method
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-Ignores the time value of money
-Ignores the cash flows after the payback period
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Concept of cost of capital
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A firm's cost of capital is the average rate it pays its investors for the use of their money
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Purpose of cost of capital
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-In general a firm can raise money from two sources: debt and equity
-If a potential project is expected to generate a return greater than the cost of the money to finance it, it is a good investment
-If cost to finance new project is 10% and expected return is 18% it creates value for …
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Financial risk
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Due to debt financing
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Business risk
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Variability of cash flows
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Different methods of accelerating cash receipts:
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Lockbox, concentration banking, preauthorized checks, wire transfers.
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HB 311: Exam 1