7. Risk & Return pt 1

Question 1

What is the required rate of return on an investment?

Answer 1

It depends on the risk, the greater the risk the greater the required rate of return

Question 2

At a minimum what must the required rate of return be more than?

Answer 2

The opportunity cost

Question 3

What are the two components of a return on investments?

Answer 3

The income component - cash flow (dividend or income)

The value component - capital gain or loss (value of the shares or value of the asset)

Question 4

How do you calculate the return on an investment?

Answer 4

Total dollar return = dividend income + Capital gain or loss

Question 5

To work out a dividend yield?

Answer 5

Divide the dividend by the price of the share

Question 6

To work out the Capital gains yield?

Answer 6

Calculated as the change in the price during the year divided by the beginning price

Question 7

What is nominal returns?

Answer 7

Return on an investment not adjusted for inflation

Question 8

What is real returns?

Answer 8

Returns adjusted for the effects of inflation

Question 9

What is the difference between nominal and real returns?

Answer 9

Nominal return on an investment is the percentage change in the number of dollars you have. Real return on an investment is the percentage change in how much you can buy with your dollars, the percentage change in your buying power

Question 10

What is the fisher effect?

Answer 10

The relationship between nominal returns, real returns and inflation

Question 11

What are the four types of financial investment?

Answer 11

Ordinary shares
Small shares
Ten-year exchange
Bank bills

Question 12

What is risk premium?

Answer 12

The excess return required from an investment in a risky asset over a risk free investment

Question 13

What has a zero risk premium?

Answer 13

The 10 year government bonds. As governments can always pay back debts (raise taxes). All other risk premiums are worked out from this

Question 14

What is a variance (stocks)?

Answer 14

The average squared deviation between the actual return and the average return

Question 15

What is standard deviation?

Answer 15

The positive square root of the variance

Question 16

What is normal distribution?

Answer 16

A symmetric, bell-shaped frequency distribution that can be defined by its mean and standard deviation.

Question 17

What are the two lessons regarding capital market history?

Answer 17

Risky assets, on average, earn a risk premium

The greater the potential reward, the greater the risk

Question 18

What is efficient capital market?

Answer 18

Market in which security prices reflect available information, which means based on the available information there is no reason to believe the current price is too high or low

Question 19

What is EMH?

Answer 19

Efficient market hypothesis. The hypothesis that actual capital markets, such as the NYSE or ASX are efficient

Question 20

If the market was efficient what would be the implication?

Answer 20

All investments in an efficient market are zero NPV investments

Question 21

What are the three forms of an efficient market?

Answer 21

Weak
Semi-strong
Strong

Question 22

What does risk and return focus on?

Answer 22

inflation and returns
average returns
the variability of returns
capital market efficiency.

Question 23

What is Capital Asset Pricing Model (CAPM)?

Answer 23

a method to evaluate risk and the expected returns.

Question 24

What is the Capital Market Line? (CML)

Answer 24

the best deals lie along the line that is tangent to the efficient frontier. This line is referred to as the capital market line