Financial Risk Management and Capital Budgeting

Question 1

Financial Risk Management and Capital Budgeting

Describe positive beta

Answer 1

Financial Risk Management and Capital Budgeting

Positive Beta- Return of investment highly correlated with return of portfolio (increase risk)

Question 2

Financial Risk Management and Capital Budgeting

Describe negative beta

Answer 2

Financial Risk Management and Capital Budgeting

Negative beta- Return of investment not correlated with return of portfolio

Question 3

Financial Risk Management and Capital Budgeting

Describe Coefficient of Variation

Answer 3

Financial Risk Management and Capital Budgeting

Coefficient of Variation Std. Deviation of investment
= _______________________
Expected Return

Question 4

Financial Risk Management and Capital Budgeting

Describe relationship between NPV and IRR

Answer 4

Financial Risk Management and Capital Budgeting

NPV > 0, IRR > Discount Rate
NPV = 0, IRR

Question 5

Financial Risk Management and Capital Budgeting

Describe the Internal Rate of Return

Answer 5

Financial Risk Management and Capital Budgeting

Internal Rate of Return- Determines the rate of discount at which the present value of the future cash flows will exactly equal the investment outlay.

Question 6

Financial Risk Management and Capital Budgeting

Describe Initial Investment in the Internal Rate of Return

Answer 6

Financial Risk Management and Capital Budgeting

Initial Investment= TVMF x Cash flows

Question 7

Financial Risk Management and Capital Budgeting

Describe the Effective Interest Rate

Answer 7

Financial Risk Management and Capital Budgeting

Effective Interest Rate = Interest Cost
__________
Funds available

Question 8

Financial Risk Management and Capital Budgeting

Describe the Effective Earned Interest Rate (EAR)

Answer 8

Financial Risk Management and Capital Budgeting
Effective Earned Interest Rate
m
EAR= (1+ (r/m)) -1

r = stated interest rate
m = compounding frequency

Question 9

Financial Risk Management and Capital Budgeting

Describe Systematic Risk

Answer 9

Financial Risk Management and Capital Budgeting

Systematic Risk- the component of the total risk of a security that cannot be eliminated through diversification and is relevant to valuation.

Question 10

Financial Risk Management and Capital Budgeting

Describe the reward/ risk ration

Answer 10

Financial Risk Management and Capital Budgeting

Reward/ risk ratio= expected return
_____________
standard deviation

Question 11

Financial Risk Management and Capital Budgeting

Describe the coefficient of variation

Answer 11

Financial Risk Management and Capital Budgeting

Coeff of variation Standard deviation of returns
= _______________________
Amount of expected return

Question 12

Financial Risk Management and Capital Budgeting

Describe the Accounting Rate of Return (ARR)

Answer 12

Financial Risk Management and Capital Budgeting

ARR Expected Increase in Annual Net Income
= _______________________________
Average Investment

Question 13

Financial Risk Management and Capital Budgeting

Describe Enterprise Risk Management

Answer 13

Financial Risk Management and Capital Budgeting

Enterprise Risk Management- Designed to identify potential events that may affect the corporation, and manage these risks within the corporation’s risk appetite.

Question 14

Financial Risk Management and Capital Budgeting

What are the advantages of Enterprise Risk Mgmt?

Answer 14

Financial Risk Management and Capital Budgeting

Advantages of Enterprise Risk Management

1) Reasonable assurance in attaining corporate objectives
2) Helps ensure risks are identified, assessed, prioritized, and managed within risk appetite
3) Improved risk/ response decisions
4) Reduce operational surprises/ losses
5) Seize opportunities
6) Deployment of capital

Question 15

Financial Risk Management and Capital Budgeting

Describe the characteristics of the Payback/ Accounting rate of return.

Answer 15

Financial Risk Management and Capital Budgeting

Payback/ Accounting Rate of Return

1) Ignores time value of money
2) Management may select investment alternatives that do not provide greatest Return on Investment (ROI)

Question 16

Financial Risk Management and Capital Budgeting

Describe the characteristics of Net Present Value

Answer 16

Financial Risk Management and Capital Budgeting

Net Present Value
- Calculates PV of future cash flows discounted at company’s cost of capital.

Question 17

Financial Risk Management and Capital Budgeting

Describe the characteristics of Internal Rate of Return

Answer 17

Financial Risk Management and Capital Budgeting

Internal Rate of Return
- Determines the rate of discount at which PV future cash flows equals the PV of investment outlays.