firm value and cost of capital

Question 1

investors (savers)…

Answer 1

• provide funding to corporate sector (borrowers)
• expect compensation in return

Question 2

what investors…

Answer 2

require from their investment is a cost to borrowers

Question 3

volatility

Answer 3

• risk and uncertainty about future prices and cashflows
• dispersion in range of outcomes of returns
• std dev of historical returns

Question 4

intervals

Answer 4

% chance of returns lying between x and y

Question 5

idiosyncratic risk

Answer 5

• specific to a business
• unlikely to affect >1 business at a time
• firm, avoidable, diversifiable
• not compensated

Question 6

systematic risk

Answer 6

• occurs on a macro-economic and global scale
• affects multiple firms at same time, usually same direction, but sometimes different degrees
• market, unavoidable, non-diversifiable, beta
• compensated

Question 7

diversification

Answer 7

• holding a number of investments in a portfolio
• mixing companies has almost zero chance of strong imbalance
• when idiosyncratic risks swing in same direction in same year, even tho events are unrelated

Question 8

market

Answer 8

• most diversified investment
• essentially zero idiosyncratic risk
• higher expected returns

Question 9

correlation

Answer 9

measures systematic risk through relationship between expected return and market

Question 10

beta

Answer 10

if B = 1 move in market, systematic risk moves by 1