...Report Task 1 Group 1 To be able to understand and cope with task one some basic concepts we have already learned in the previous finance course must be refreshed and explained once again. There are two types of risk called the firm-specific/idiosyncratic risk and the systematic/market risk. The distinction between those is that firm-specific risk only affects the company itself and can be diversified. For example, the top manager leaves the company because he has been offering a better job. This risk can be diversified by hiring someone else and does not affect the whole economy. The market risk affects all stocks simultaneously and cannot be diversified. An example would be an earthquake. Since diversification cannot eliminate market risk the risk premium only depends on it. Another concept is the Capital Asset Pricing Model. There are three main assumptions that underlie the CAPM and allow us to identify the efficient portfolio of risky assets. 1. Securities are traded at competitive market prices 2. Investors choose efficient portfolios 3. Investors have homogenous expectations When these assumptions hold, the market portfolio and the efficient portfolio coincide. The efficient portfolio is the point where the capital market line, which is the line from the risk-free investment through the market portfolio, is tangent to the efficient frontier and represents the highest expected return available for any level of volatility. If we go up the efficient...
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...Stock: a) Using 12 percent 1.90 x (1.05/0.07) = $28.50 b) Using 15 percent 1.90 x (1.05/0.10) = $19.95 c) When a required rate of return goes up, the anticipated price goes down. In other words, the ‘better deal’ on the stock (lower price) gets you a higher overall return. Bond: a) The present value of that stream of payments is $785.45. b) When annual interest rate changes to 12.36%, i calculated the semiannual rate (which is 6%) and the present value is re-calculated as $917.59. Beta: a) Beta = (return – riskless rate) / market premium Therefore, Beta = (12% - 5%) / (10%) = 0.7 b) If the stock’s beta was 2.0, then we would expect a much higher return. Therefore, Return = (5%) + (10%) x (2.0) = 25%. c) The market return is the riskless rate + the market premium = 5% + 6% = 11%. Therefore, Return = (5%) + (6%)x(1.2) = 12.2% d) Market premium = market return – riskless rate 13% - 6% = 7%. Therefore, return = (6%) + (7%) x (0.7) = 10.9% e) Beta = [(35 x 0.8) + (40 x 1.4)]/75 = 1.12 The beta of her portfolio would be 1.12 Research: Investors use the concept of risk tolerance when dealing with stocks in bonds with the idea of “not putting all of your eggs in one basket.” This means that an investors portfolio needs to be very diverse. According to Investopedia, “mutual fund portfolios composed of a mix, which includes both stocks and bonds, are referred to as "balanced" portfolios. The specific balance of stocks and bonds in a...
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... | | | | | | | CONTENTS ➢ Acknowledgement……………………………….. ➢ Objective…………………………………………1 ➢ Covariance………………………………………. ➢ Correlation………………………………………. ➢ Beta and its role…………………………………. ➢ Beta coefficient………………………………….. ➢ Capital asset pricing model (capm)……………... ➢ Cost of equity……………………………………. ➢ Weighted average cost of capital (wacc)………... ➢ Bibliography……………………………………... ACKNOWLEDGEMENT I would like to express my gratitude to our finance professor MR. JADHAV ADITYA MOHAN who gave us the opportunity and subsequent guidance to complete this project. A mission of this project was to get practical insight of the chemical and fertiliser industry. This project helped us in learning of financial concepts by applying them and ascertaining the various financial details of the companies. At last the team work and effort showed by each group member made this project a success. OBJECTIVE To calculate and interpret the value of Beta calculated using the returns of selected companies of Chemicals and fertilizer industry of India and deriving at the conclusion as to which company to invest in considering the risk taking...
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...Running head: UNDERSTANDING THE CONCEPTS Understanding the Concepts Freddie Bailey FIN 100 Professor John Underwood May 27, 2012 Identify the components of a stock’s realized return. A realized return is the amount of actual gain that is made on the value of a portfolio over a specific evaluation period. The components of a stock are realized return is dividends, distributions, and share price appreciation. Dividends play a very important role in stock realized dividends may be in the form of cash, stock or property. Most secure and stable companies offer dividends to their stockholders. High growth companies will not likely offer dividends, because all of their profits are reinvested to help sustain higher than average growth. Distribution in realized stock is either money a mutual fund pays its shareholder from the dividends or interest it earns or from capital gains, it realizes on the sale of securities in its portfolio. The term distribution is also used to describe certain actions a corporation takes. Share price appreciates is when a share increases in value, it appreciates (Anderson, 2001). Contrast systematic and unsystematic risk. Systematic risk is also known as the non-diversifiable risk. There is a relevant portion of an assist’s risk attributable to market factors that have an effect on all firms such as war, inflation, international incidents, and political events. Unsystematic risk also known as diversifiable risk...
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...Thoughts on Smart Beta Chao Liu May 22 2014 The two articles in FT introduce the recent popular investment strategy: smart beta. Smart beta concept is growing popularity across the world because it has allegedly been providing investors risk-adjust excess return. Some consider smart beta approach as a strategy lies between traditional active management in which the fund managers actively pick stocks for their portfolios, and the passive management in which the investor simply replicate the market index. One way to create smart beta portfolios is to substitute the market cap weighting method with an alternative weighting, and the other more popular way is to track certain stocks or certain parts of the market using certain risk factors. These certain risk factors have been recognized to provide risk premium in academia. For example, we have learned in this semester that there are many return anomalies existed in past several decades such as small cap stock, value stock and momentum effect. Those factors are not new to investors, so investors can decide whether take these factors into consideration when forming their investment portfolios. The central questions to ask are: What sources of returns are accounted for smart beta strategies? Can smart beta strategies offer consistent higher risk-adjusted return over time? From the perspective of efficient market theory, any excess return over a market index is due to higher risk bearing. As we can learn from the two FT articles...
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...CHAPTER 9 RISK AND RETURN FOCUS Our initial focus is on defining risk in financial terms and understanding how that concept fits into portfolio theory. As we gain a more sophisticated understanding of risk, we're able to focus on the concept of beta and how to apply it through the SML. PEDAGOGY The study of Risk and Return presents the biggest pedagogical challenge in basic finance. Therefore motivating the study and developing ideas patiently is especially important. Students are easily confused early in the discussion by the transition from the everyday notion of risk to its financial representation as variation in return. We therefore take pains to present these ideas carefully through an intuitive illustration. Risk and Return is also the area in which textbook treatments using mathematical statistics get students who aren't good at math into the most trouble. The approach used here presents statistical concepts graphically and in words to overcome this pedagogical roadblock. It's worth noting that while we minimize the statistics used in the theoretical development of the CAPM, we don't skimp on the algebraic math required to apply the SML. TEACHING OBJECTIVES Instruction should begin motivating the study of risk and return by explaining that higher long-term returns are available on equity than on debt but that there's an associated risk. Point out that the objective of investing is to take advantage of the high...
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...‘The Capital asset pricing model (CAPM) is a very useful model and it is used widely in the industry even though it is based on very strong assumptions. Discuss in the light of recent developments in the area.’ MN 3365 Strategic Finance Table of Contents Introduction Concept of CAPM Assumptions of CAPM . Other Suggested Models Disadvantages of CAPM Advantages of CAPM Problems in applying CAPM Conclusion Bibliography / References INTRODUCTION This essay will highlight the use of Capital asset pricing model ( CAPM ) to be considered as a pricing theory model for assets . CAPM model helps investors to analyse the risk and what expectation to keep from an investment (Banz , 1981) . There are two types of risk associated with CAPM known as systematic and unsystematic risk . The systematic risks are market risk which cannot be diversified such as fluctuations in interest rates and recession in the economy .Unsystematic risk are risks associated with an individual stock , it occurs when an investor increases the number of stocks on his portfolio. The unsystematic risk cannot be diversified as it is related an individual stock irrespective to the general market . (Amihud and Lev, 1981). The CAPM was introduced independently by Jack Trenor (1961 , 1962) , Jan Mossin (1996) and William F . Sharpe (1964) , it is basically an uplifment of the existing work of Harry Markowitz on modern portfolio therory as well as diversification which was given a name as...
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...pROJECT ON FINANCIAL MANAGEMENT | ESTIMATION OF BETA AND ITS INTERPRETATION IN AN INVESTMENT DECISION | Submitted to: | Prof. S P Mohapatra | | | Submitted By: Aditya Prakash (11DM061) Amitava Mitra (11DM062) Paritosh Beuria (11DM063) Subhajyoti Bhattacharya (11DM064) INSTITUTE OF MANAGEMENT & INFORMATION SCIENCE, BHUBANESWAR. | CONTENTS Page No. * OBJECTIVES 3 * COMPANY PROFILES 4 i. Mahindra Finance ii. Unitech Ltd. * PROJECT METHODOLOGY AND ANALYSIS 5 * Objectives of the project * Scope of the project * Concepts * Excel Analysis * Computational Aspects * INTERPRETATION AND CONCLUSION 11 * REFERENCES 11 OBJECTIVES * To select the stocks of two companies from different sectors to invest. * To determine the beta value for each of the stocks for last financial year on the basis of National Stock Exchange (NSE) and interpretation of beta. * To determine a minimum risk portfolio by using the two stocks. Company Profiles Mahindra Finance Mahindra & Mahindra Financial Services Limited is one of the leading non-banking finance companies in India. It is among the top 500 Indian companies by market capitalization. For the fiscal ended 31 March 2011...
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...Stock Garnett Incorporated earned $2.60 per share and paid a dividend of $1.90 per share in the year just ended. Earnings and dividends per share are expected to grow at a rate of 5 percent per year in the future. Determine the value of the stock: Dividend * (1 + growth) / (overall return – growth) a. If the required rate of return is 12 percent.: 1.90 * (1.05 / 0.07) = $28.50 b. If the required rate of return is 15 percent. 1.90 * (1.05 / 0.10) = $19.95 c. Given your answers to Parts a and b, how are stock prices affected by changes in investor's required rates of return? When the higher overall return is the lower the stock is. When the anticipated price goes down the return rate goes up. Bond Garnett Corporation has also issued bonds which have a face value of $1,000, will mature in 10 years, and carry a coupon rate of 16 percent. Assume interest payments are made semiannually. a. Determine the present value of the bond's cash flows if the required rate of return is 16.64 percent. Present value= $785.45 b. How would your answer change if the required rate of return is 12.36 percent? $917.59 Paying less for the same payment gives you a higher yield, so when the bond rates go down the present value goes up. Beta Calculate the beta by assuming that the risk-free rate designated by r RF = 5%, the market risk premium designated by r M = 10%, and the expected rate of return for stock A is designated by r A = 12%. a. What is the beta for Stock...
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...INTRODUCTION We are required to collect stock prices of 35 public listed companies. There are 20 Malaysia, 5 United State, 5 United Kingdom, 5 Indonesia and KLCI index for the period of 2006 until 2013 based on weekly basis. Malaysia stock prices in this project based on Bursa Saham Malaysia. The stock prices of 20 Malaysia public listed company named by Prostaco, Raya International, Tiong Nam, Tong Herr, Toyo Ink, TSH, Turiya, United, Vitrox, UPA Corporation, Zecoon, Yokohama Industries, Woodlandoor, Wong Engeenering, White Horse Berhad, Whelcal Holding, Weida, Warisan TC Holding, Yinson Holding Berhad and YTL Power. While, the stock prices of 5 United State public listed company named by Adobe System INC, Alaska Air Group INC, Apple INC, The Aes Corporation and The NewYork Mellon Corporation. For stock prices of 5 United Kingdom public listed company named by Barclay, Bg Group, Big Yellow Group, Black Mount and Bovis Homes and lastly for the stock prices of 5 Indonesia public listed company named by Astra International, Bank Central Asia, Bank Danamon Indonesia, Kimia Farma and Unilever Indonesia. We also are required to demonstrate and explain the computations of annual return, risk, Sharpe ratio, return, covariance, beta, Treynor Ratio, portfolio standard deviation, and build a graph. THEORETICAL CONCEPTS In this assignment, we used the formula of Variances, Annual, Standard Deviation, Covariance, Correlation Coefficient, Beta, Variance Of Portfolio, Risk, Sharpe Ratio...
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...Understanding the Concepts William Gould Finance 100 Dr. Crawford March 7, 2013 Strayer University, Augusta Campus Owning and operating your own business is a goal of most Americans. The thing about owning your own business is to understand the concepts of operating a small business. When thinking about starting a small business, a person must have a well written business plan. A business plan is an “a formal document that describes a business concept, outlines core business objectives, and details strategies and timelines for achieving those objectives” (Kelly & McGowan, 2012).A business plan consist of marketing: products and services offered, demand from customs, market and location, advertising and marketing plan and pricing strategy, Financial Management: amount needed to start, expected cash flow, projected income and balance sheet, etc...Operation: daily management, hiring and personnel policies, insurance coverage and leasing agreement (Gordick, 2003). Within a small business, a small business owner must be able to keep track of the money that is coming in and going out. Using the different financial source and equation to operate your business is essential in owning and operating a small business. Understanding the concepts will help you own, operates and sustain a small business. NPV and payback is a concept a small business owner must understand, when making decision in a small business. NPV or net present value method is a dynamic investment appraisal...
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...000) / $1,000 = 10%. 5-2 What is investment risk? Two types of investment risk Stand-alone risk Portfolio risk Investment risk is related to the probability of earning a low or negative actual return. The greater the chance of lower than expected or negative returns, the riskier the investment. 5-3 Probability distributions A listing of all possible outcomes, and the probability of each occurrence. Can be shown graphically. Firm X Firm Y -70 0 15 Expected Rate of Return 100 Rate of Return (%) 5-4 Selected Realized Returns, 1926 – 2001 Small-company stocks Large-company stocks L-T corporate bonds L-T government bonds U.S. Treasury bills Average Return 17.3% 12.7 6.1 5.7 3.9 Standard Deviation 33.2% 20.2 8.6 9.4 3.2 Source: Based on Stocks, Bonds, Bills, and Inflation: (Valuation Edition) 2002 Yearbook (Chicago: Ibbotson Associates, 2002), 28. 5-5 Investment alternatives Economy Prob. T-Bill HT Coll USR MP Recession 0.1 8.0% -22.0% 28.0% 10.0% -13.0% Below avg 0.2 8.0% -2.0% 14.7% -10.0% 1.0% Average 0.4 8.0% 20.0% 0.0% 7.0% 15.0% Above avg 0.2 8.0% 35.0% -10.0% 45.0% 29.0% Boom 0.1 8.0% 50.0% -20.0% 30.0% 43.0% 5-6 Why is the T-bill return independent of the economy? Do T-bills promise a...
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...and return of individual stocks? If I were Bill, I would explain to Mary that the relationship between risk and return is simply the additional compensation for bearing risk. If she were to invest in more risky securities, the return may be higher, but if the market falls, her losses could also be quite large. With risky assets, the possibility of it losing value is also greater, compared to a risk-free or low-risk asset. As Mary is described to be a ‘conservative and cautious’ person, she would need to move out of risky assets and invest in lower-risk securities. In order to have a guaranteed expected return, she must invest in securities or assets that are low-risk but would not have as big of a return 2. Mary has no idea what Beta means and how it is related to the required return of her stocks. Explain how you would help her understand these concepts. The Beta is an indication of the amount of systematic risk present in a risky investment, compared to an average risky asset. The beta only represents systematic risk, as unsystematic risk can be diversified enough that it does not exist. An asset with a beta of 1 means that it is of average risk compared to the market. Essentially, the beta of a particular asset will tell you how the stock will perform if the market were to change. If the asset Mary is holding as a beta of 2, and the market dropped by 20%, that particular risky asset with a beta of 2 will drop by 40%. Securities with high beta will have high volatility...
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...1.2 | The Corporate Firm | 4 | | The Sole Proprietorship | 4 | | The Partnership | 4 | | The Corporation | 5 | | A Corporation by Another Name . . . | 7 | 1.3 | The Importance of Cash Flows | 7 | 1.4 | The Goal of Financial Management | 10 | | Possible Goals | 11 | | The Goal of Financial Management | 11 | | A More General Goal | 12 | 1.5 | The Agency Problem and Control of the Corporation | 13 | | Agency Relationships | 13 | | Management Goals | 14 | | Do Managers Act in the Stockholders' Interests? | 14 | | Stakeholders | 15 | 1.6 | Regulation | 16 | | The Securities Act of 1933 and the Securities Exchange Act of 1934 | 16 | | Sarbanes-Oxley | 17 | | Summary and Conclusions | 18 | | Concept Questions | 18 | | S&P Problems | 19 | 2 Financial Statements and Cash Flow 20 2.1 | The Balance Sheet | 20 | | Liquidity | 21 | | Debt versus Equity | 22 | | Value versus Cost | 22 | 2.2 | The Income Statement | 23 | | Generally Accepted Accounting Principles | 24 | | Noncash Items | 25 | | Time and Costs | 25 | 2.3 | Taxes | 26 | | Corporate Tax Rates | 26 | | Average versus Marginal Tax Rates | 26 | 2.4 | Net Working Capital | 28 | 2.5 | Financial Cash Flow | 28 | 2.6 | The Accounting Statement of Cash Flows | 32 | | Cash Flow from Operating Activities | 32 | | Cash Flow from Investing Activities | 32 | | Cash Flow from Financing Activities | 33 |...
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...Corporate Finance 1. Time value of money This concept discuss about the future value and the present value of money. For example a dollar today has more value than the dollar you will be earning in the future. Time value of money is a very important concept because it will help make decision on how much to save today to have a certain amount of saving for retirement in future. Interest rate and a time line also plays an important role in analyzing the time value of money. For Individuals the implications can be seen when deciding how much to save for retirement, valuing stocks when doing a personal investment or when calculating loan repayment schedule. For a corporation time value of money concept comes in to play when evaluating a project financial viability, when making new investment in plant and machinery and when investing in stocks and bonds. 2. Bonds I was able to learn about the types of bonds issued in the market and the risk associated with the bond market, pricing of the bonds, relationship between bond price and interest rate. A bond is a long term debt instrument issued by a corporate or a government in order to raise capital. This is a contract under which the borrower (a corporate or a government) agrees to make a payment of principle and interest on a specific future date to the holder of the bond. Corporate Bond, Treasury bond, high-yield corporate bonds (low quality also known as junk bonds), foreign bonds, mortgage-backed bonds and municipal...
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