........................... 4 Chapter Three: How Securities Are Traded........................................................................ 8 Chapter Six: Risk and risk aversion.................................................................................. 12 Chapter Seven: Capital Allocation between the Risky asset and the risk-free Asset ....... 17 Chapter Eight: Optimal Risky Portfolios:......................................................................... 20 Chapter Nine: The Capital
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Analysis: 1. ARAMIT: The expected rate of return is higher than the estimated rate of return and as a result the share of this company is overpriced. Institute holds more shares and government has no contribution here for investing so there is high risk and another issue for high risk is that the beta is more than one. This company issues bonus shares sometimes. Its P/E ratio represents that the share is fairly valued and the growth of earning is rising slowly. Net asset value per share is good
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CHAPTER 6: RISK AVERSION AND CAPITAL ALLOCATION TO RISKY ASSETS PROBLEM SETS 1. (e) 2. (b) A higher borrowing rate is a consequence of the risk of the borrowers’ default. In perfect markets with no additional cost of default, this increment would equal the value of the borrower’s option to default, and the Sharpe measure, with appropriate treatment of the default option, would be the same. However, in reality there are costs to default so that this part of the increment lowers
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all couples of assets i and j), then by buying strictly positive amount of each asset, you can: Obtain a portfolio that is risk-free. Obtain a portfolio that is free from systematic risk. Obtain a portfolio that is free from idiosyncratic risk. Obtain a negative risk portfolio. Obtain portfolio whose expected return is larger than the largest expected return of the asset composing the portfolio. b) Which one of the following cannot be a good reason for short selling an asset? You
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Financial Risk 1. Compare the stand-alone risk / return of each of the five investment alternatives listed in Exhibit 13.1. 2. MSI is considering two investment strategies: - 50 percent in Project A and 50 percent in Project B (Portfolio A / B) or - 50 percent in Project A and 50 percent in the S&P 500 Fund (Portfolio A / S&P). Compare the risk of the two portfolios. Why does the risk differ? 3. a. Compare the corporate risk of Projects A and B. (Hint: Use the expected returns in Exhibit 13
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dividend. This means that the dividend pay-out ratio is 100% and there are no earnings that are retained by the firms. 4. The total assets are given which do not change and the investment decisions are assumed to be constant. 5. Business risk is constant over time and it is assumed that it is independent of the capital structure. 6. The firm has a perpetual life. 7. The firm’s earnings before interest and taxes are not expected to grow. 8. The firm’s total financing remains
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characteristic risks (RP). The nominal rate of interest for a security can be defined as r1 r* IP RP. For a 3-month U.S. Treasury bill, the nominal rate of interest can be stated as r1 r* IP. The default risk premium, RP, is assumed to be zero since the security is backed by the U.S. government; this security is commonly considered the risk-free asset. 2. The term structure of interest rates is the relationship of the rate of return to the time to maturity for any class of similar-risk securities. The
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Solution & Analysis QUESTION 1 ZEUS’s INVESTMENT PHILOSOPHY The investment philosophy of the management of Zeus is based on the fact that the results of the investment or the return over the investment could be only achieved over the years by following a risk averse and conservative approach to the management of the risk. This ensures that the portfolio manager of the company works hard to deliver the best performance that is relatively the same as compared to the benchmark’s performance. The equity
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internal rate of return on the project, or how much money the project will generate, can be compared to the cost of capital, which is the cost of financing such a project. If the rate of return exceeds the cost of capital, the project is probably a good one (in terms of cost only). The cost of capital takes into account the cost of debt and the cost of equity. The cost of debt could be the effective interest or coupon rate a firm currently pays on its debt. It could also be the rate of return required by
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Principle 1. The risk-return trade-off Principle 2. The time value of money Principle 3. Cash—Not Profits—is King Principle 4. Incremental cash flows Principle 5. The curse of competitive markets Principle 6. Efficient Markets Principle 7. The Agency Problem Principle 8. Taxes bias business decisions Principle 9. All risk is not equal Principle 10. Ethical dilemmas persistTen principles of finance are listed and explained in this ahort lecture. Principle 1. The risk-return trade-off Principle
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