Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Investment Management > Chapter 6 - Risk and Return > Flashcards

Chapter 6 - Risk and Return Flashcards

1
Q

what do rational investors require?

A

require the highest possible return and the lowest possible risk exposure

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

the relationship between risk and return

A

positive

The higher the expected return the higher the risk of exposure

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What does return on an investment represent?

A

The expected benefits that will be earned

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Determine the return

A

determine the profit

calculate the rate of return

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

The rate of return formula

A

expected price @ year end - current price / current price x 100

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

single period return

A

keep investment for a certain period of time ( 1 year)

two forms of return for stock investment: dividend or captial profit/loss

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

single period return formula

A

capital P/L + dividends / initial price x 100

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What are the advantages of single period return?

A

Simple to calculate

simplifies the comparison between different investments

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

what are the disadvantages of the single period return

A

method does not take the time value of money into consideration

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is the internal rate of return?

A

an investment held for a longer period of time and a series of dividend payments is received.
(discount rate- if the present value of all future receipts is calculated by using IRR = present price of share.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

Advantages of using internal rate of return

A

the time value of money is take into consideration

makes provision for more than one period

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

disadvantages of the internal rate of return

A

expected future values are required

large degree of uncertainty regarding future dividend income and the selling prices

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is risk

A
  • Probability that the actual performance may differ from the expected return
  • investor will be negatively influenced
  • unexpected deviation from the expected return
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

systematic risk

A

occurrences in financial markets

  • all the risks that are the result of changes in the total economy
  • influence all enterprises and investments
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Types of systematic risk

A 
interest rate risk 
cyclical risk 
inflation risk 
exchange rate risk 
market risk
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Interest rate risk

A

The probability that the change in interest rates will have a negative effect on the return of an investment.
Inverse relationship

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

How does the negative effect of the interest rate impact share prices

A

difference exists between the risk of exposure and fixed deposit. investors decide to invest their funds in the fixed deposit (safer) if the return is high enough. (d decreases and SP drop).

increase in interest rate = higher FC that use DC to finance their investments. if return is not high enough to make up the increate in ir they will sell their shares = decrease SP

18
Q

Methods that decrease interest rate risk

A

1) Buy securities with short remaining term
2) Hold fixed income securities until maturity date
3) Conducting a thorough analysis of variables that influence interest rate decisions, such as the variables considered by monetary authorities

19
Q

What is cyclical risk

A

The probability that share prices will be negatively influenced by changes in the economic cycle

20
Q

Methods to reduce cyclical risk

A

diversification over time
diversification between different types of investments
timing

21
Q

inflation risk

A

The value of money decreases constantly as a result of inflation - negative impact on returns

22
Q

Real rate of returns

A

(1+ nominal return / 1 + inflation rate ) - 1 x 100

23
Q

How do I hedge against inflation risk

A
  • internal diversification
  • balanced diversified portfolio
  • timing
  • inflation linked securities
24
Q

What is exchange rate risk

A

The uncertainty regarding returns for the investor that are exposed to foreign securities

  • the more volatile the exchange rate between 2 countries the higher the exchange rate risk
25
Q

How can investors protect themselves from exchange rate risk

A

exchange rate cover
thorough analysis of the company
internal diversification

26
Q

What is market risk

A

The probability that the mp of an investment will differ from its intrinsic value due to irrational investor behaviour.

Mp> intrinsic overvalued
Mp< intrinsic undervalued

27
Q

What must investors consider in order to protect themselves from market risk

A

timing
longer investment term
international diversification
through analysis of the share

28
Q

Non- systematic return

A

actions of the enterprise itself - enterprise influences the extent of the risks

29
Q

Types of non systematic risk

A

operating risk
financial risk
industry risk
other risk factors

30
Q

What is operating risk

A

operating profit is influenced by the nature of the the enterprises activities and the effect of operating gearing.
Effect of changing market conditions on operating profit
An enterprise with a large component of fixed costs in its costs structure
Highest for enterprises with:
Unsteady revenue streams
Large % of fixed costs in the cost structure

31
Q

what is financial risk

A

The way in which an enterprises is financed influences its exposure to financial risk.
measured by means of financial gearing.

If an enterprise includes debt capital in its capital it can lead to increased instability of the return of equity and the EPS.

32
Q

Negative and positive financial leverage

A

positive : cost < return on assets - cost of debt capital is lower than return on total assets

negative: cost>return on assets - cost of debt capital higher than return on total assets

33
Q

methods to decrease exposure to financial risk

A

Analysis of an enterprises capital structure

market interest rates

34
Q

what is Industry risk

A

some risks are limited to specific industries. only enterprises active in these industries are influenced by these risks.

Different factors that might give rise to this risk. For example, dependence on specific raw material, high labour intensity, capital intensity, technological changes

35
Q

Hedging against industry risk

A

Thoroughly informed about situations that may occur within a specific industry
Thorough investigation of the branch of industry

36
Q

Other risk factors for non systematic risk include

A 
Bad inventory control
Changes in top management
Legal actions taken against the enterprise
Weak liquidity
New competitors
Outdated technology
37
Q

what is Quantification of risk

A

A positive relationship usually exits between the risk of an investment and the reign required by investors.

38
Q

what do Rational investors require

A

a certain minimum return on any investment.
return will be more or less equal to the return that can be earned (risk- free investment)

if slightly more risky then risk free investment requires a risk premium to reward them for the additional risk exposure. (size depends on investor

39
Q

Risk adverse investors vs risky investors

A

risk adverse require relatively large risk premiums while more risky investors require a smaller premium.

40
Q

The beta- analysis

A

Beta-indicates how sensitive a share’s price is relative to the price of other shares in the specific market (risk measure)

Determines how a share’s price will react to changes in a specific sector or the market as a whole

41
Q

The system developed to measure the beta system

A

the Barra system

β > 1: Share is more sensitive than the market
β < 1: Share is less sensitive than the market

β = 1: Share prices move with the market

42
Q

Which shares will be included with certain beta portfolios

A

The type of share and the specific beta that is preferred depends on the economic cycle
Bull market – high beta
Bear market – low beta

An investor will consider a number of factors before an investment decision is made, for example:
Beta in combination with market value and intrinsic value

Investment Management (6 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions