Topic 7 Flashcards Preview

Corporate Finance Management > Topic 7 > Flashcards

Flashcards in Topic 7 Deck (43)
Loading flashcards...
1

Average returns were used to analyse _______ returns in financial markets based on actual events.

historical

2

__________ of returns of an investment represents its risk and is measured by variance and standard deviation.

Variability

3

In Part 2, we calculate projected future returns based on probabilities of economic state in future. We call these ___________.

expected returns

4

________ is a group of assets held by an investor.

Portfolio

5

___________ is how many percents a particular asset contributes to the total value of the portfolio.

Portfolio weight

6

_________ on a portfolio is calculated based on portfolio weight.

Expected return

7

What will determine the value of a share’s return next year?

There are two components: expected and unexpected returns.

8

Expected return is part of the return that investors already predict, based on the information the shareholders have _______ that will influence the return in upcoming year

today

9

Unexpected return is the ________ part; the portion that comes from unexpected information revealed within the year, for example:
+ unexpected change in commodity prices (imagine if iron ore prices suddenly fall sharply!)
+ News that company’s sales figures are better than expected
+ News about the CEO’s sudden resignation.

risky

10

Total return = Expected return + _________ return

R = E(R) + U

Unexpected

11

So, what is risk?

Risk is the unexpected part of the total return!

12

Unexpected events comprising the unexpected part of total return can be divided into:

-- Systematic risk: Risk affecting a large group of investments; also called _______

-- Non-systematic risk: Risk affecting only a single or a small group of investments; also called _______

market risk.

unique risk.

13

Total return = __________ + Systematic portion + Non-systematic portion

Expected return

14

THE EFFECT of DIVERSIFICATION:

- If a portfolio contains a number of diversified shares, its standard deviation would be _______ than the average standard deviation of individual share.

- The more the number of shares in the portfolio, the _______ the portfolio’s standard deviation.

lower

lower

15

A relatively large and diversified portfolio has almost no _________ risk.

non-systematic

16

Systematic risk principle states that, because non-systematic risk can be eliminated by diversification, expected return on a risky asset depends only on the asset’s ________

systematic risk.

17

So, how do we measure systematic risk?

Beta coefficient (β) measures the amount of systematic risk in a particular investment relative to an average risky investment in the market.

+ An investment with a beta of 0.50 has half the systematic risk that an average risky investment has.

+ A beta of 2.00 means the investment has twice the systematic risk an average risky investment has.

18

Because the expected return on a risky asset depends on systematic risk, the _______ the beta of an asset, the _______ the expected return

higher

higher

19

Portfolio beta is measured based on ___________. Example: If a portfolio has 70% investment in Share A (beta = 1.58) and 30% in Share B (beta = 0.86), the beta of the portfolio is:
βP = (0.70 x 1.58) + (0.30 x 0.86)
= 1.10 + 0.26
= 1.36

portfolio weight

20

The security market line (SML) shows the relationship between _________ and beta.

expected return

21

Capital asset pricing model (CAPM) is the ________ showing the relationship between expected return and beta.

formula

22

The formula shows CAPM has three components:

+ Pure time value of money, as measured by the _______, which is the reward for merely waiting for your money without taking any risk

+The reward for bearing systematic risk, as measured by market risk premium [E(RM) – Rf], which is the amount of reward for bearing the systematic risk of an average risky asset in the market

+The amount of systematic risk, as measured by beta, which is the amount of systematic risk present in the asset, relative to an average risky asset

risk-free rate

23

Expected return: return on a risky asset expected __________.

in the future

24

We can calculate the ________ or expected risk premium as the difference between the expected return on a risky investment and the certain return on a risk-ree investment.

projected

25

The economy has equal probability of going into recession, boom or remaining at the current level. The current level of return for a firm is 8%. It is forecast to return 12% in a boom period and 4% in recession. What is the expected return for the firm?

Expected return = [12% + 8% + 4%]/3 = 8%

26

Portfolio: ______ of assets, such as shares and debentures, held by an investor.

group

27

Portfolio weight: ______ of a portfolio's total value in a particular asset.

percentage

28

Total return = Expected return + ________ return

Unexpected

29

Please explain what part of this information reflects surprise to market participants. Before the market opened on 3 May 2012, Westpac announced a 1% drop in cash earnings for the half year to March 2012. Fortunately, the share price increased by 17 cents at the open, in spite of a slightly weaker opening for the market from the closeof the day before. Seven days later rival National Australia Bank announced that its corresponding half - year cash earnings increased by 1.3%. Its price dropped by 9 cents. The market again experienced a relatively flat open

The data suggests that as the market expected cash earnings to drop by more than 1 per cent for Westpac, Westpac's results was acceptable to the market. National Bank's earnings would appear to have disappointed slightly. Another reason for these movements could be the political problems Greece was experiencing during this period, which in turn may have affected the market's interpretation of the accurancy of the individual banks' future earnings projections

30

The risk of owning an asset comes from surprises--- ________ events

unanticipated