finance, risk is defined as the likelihood that we will receive a return on an investment that is different from the return we expect to make. There is a trade-off between risk and expected return. Risk in investment has to be viewed in the marginal investors’ perspectives who set the stock prices. ↕ The objective in corporate finance is the maximization of firm value and stock price. Equity Risk and Expected Return Defining the risk In addition to the expected return of an investment
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Solution Lawrence J. Gitman CHAPTER 5 Risk and Return INSTRUCTOR’S RESOURCES Overview This chapter focuses on the fundamentals of the risk and return relationship of assets and their valuation. For the single asset held in isolation, risk is measured with the probability distribution and its associated statistics: the mean, the standard deviation, and the coefficient of variation. The concept of diversification is examined by measuring the risk of a portfolio of assets that are perfectly
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project should not be undertaken as we consider the inflows of yr 5-7 as an opportunity cost of discontinuing the business in yr 4. Also we assume to recover the investment in working capital at the end of the 4 year. IRR: The internal rate of return tells us the rate at which the NPV of a project
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CHAPTER 2 RISK AND RETURN: PART I (Difficulty: E = Easy, M = Medium, and T = Tough) True-False Easy: (2.2) Payoff matrix Answer: a Diff: E [i]. If we develop a weighted average of the possible return outcomes, multiplying each outcome or "state" by its respective probability of occurrence for a particular stock, we can construct a payoff matrix of expected returns. a. True b. False (2.2) Standard deviation Answer: a Diff: E [ii]. The tighter the probability
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COURSE TITLE: FINANCIAL MANAGEMENT TEACHER: FAIZA SAJJID ASSIGNMENT NO: 02 TOPIC: IMPORTANCE OF RISK AND RETURN SUBMITTED BY: MUBASHIR TARIQ, JASIM RASHID, WAQAS AHMAD REGISTRATION NO: FA10-BBA-043, 048, 035 DATED: 26/9/2012 TOPIC: IMPORTANCE OF RISK AND RETURN IN FINANCIAL MARKETS RISK: In normal terms; Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable
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QUESTIONS Joel Hasbrouck Adapted from problems originally composed by William L. Silber . I. 1. Midterm questions Assuming that the proceeds of each year are reinvested in the following years, calculate the geometric average annual return from the following sequence of returns: YR 1 = +.20, YR 2 = .15, YR 3 = +.10, YR 4 = +.06 (a) .1263 (b) .0525 (c) .0835 (d) .0443 According to modern portfolio theory, the idea that investors with different indifference curves will hold the same portfolio of risky securities
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Risk and Rates of Return Risk – The chance that some unfavorable event will occur; investment risk can be measured by the variability of the investment’s return. Stand-Alone Risk • Probability Distributions Subjective (estimated) Objective (historical) Continuous Discrete • Expected Rate of Return … weighted average of all possible outcomes … the rate of return expected to be realized from an investment … the mean value of the
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exposure to risk factors, we assumed that: Rit+1=a+bi,1F1t+bi,2F2t+…+bi,nFnt+eit+1 First, we calculated z-score for logarithm of b_p and logarithm of cap to determine sensitivities for stock-specific factors. After we got all 13 sensitivities, we did a weighted regression of the 13 sensitivities against the 1000 stock’s forward return in 60 periods, respectively. For each period, we got 13 coefficients, which were the risk premiums for each risk factor. Finally, we regressed the risk premium
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|Return | |T-bond |25% |0.02 | |Microsoft |20% |-0.33 | |Time Warner |10% |0.11 | |Disney |20% |0.02 | |Motorola |10% |-0.05 | |Home Depot |15% |-0.02 | | | | | |Average Return
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Sharpe Ratio and the Information Ratio Sharpe Ratio and Information Ratio used to determine the risk-adjusted return of an investment portfolio. Sharpe Ratio The Sharpe Ratio introduced a method of assessing manager performance relative to risk taken. Sharpe Ratio centres on the use of a RFR, this places all mangers on a level playing field regardless of style. (Expected Portfolio Return – RFR) / Portfolio Standard Deviation Hypothetically, investors should always be able to invest
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