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MBA > Week 3 > Flashcards

Week 3 Flashcards

1
Q

risk & being a manager

A

-risk comes in many different forms and different levels of severity
- part of being a good manager is being able to understand the nature of the risks their firm faces & determien the return necessary to make the risk worth bearing

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2
Q

what must you calculate for any risky decision your firm makes

A

what return is necessary is necessary to make the risks worth bearing

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3
Q

what type of relationship is between risk & return

A

direct/positive relationship between perceived risk & required return

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4
Q

what type of risk is between value & discount rate

A

inverse

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5
Q

what is used to value the firm’s common shares

A

direct relationship between risk and return, since the return to shareholders is used as the discount rate for valuing the firm’s common shares

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6
Q

how is percentage return (yield) on an investment measured

A

measured as the change in the value of the investment over the time period in questoin plus any cash flows from the investment divided by the value of hte investment at the beginning of hte time period

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7
Q

what is the cash flow for stocks during the year

A

dividends for stock

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8
Q

what does stock pay

A

dividends

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9
Q

what is the cash flow for bonds paid throughout the year

A

interest payments for bonds

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10
Q

what do people in fnance mean when they reter to “returns”

A

they means percentage returns, not dollar returns

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11
Q

what does percentage returns indicate

A

percentage returns indicate the size of the return relative to size of hte investment and therefore can be use to compare returns for different investments, regardless of the amount invested
(me and a friend invested in two different stocks. end of year, I earned $1K and friend earned $500. Who did better? look at how much we each invested and the % returned. if I invested more but got 20% return while she invested less but got 50% return, she did better)

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12
Q

calculate total return for stocks

A

total return = dividend yield and capital gains yield

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13
Q

dividend yield

A

percentage return from dividends

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14
Q

percentage return from dividends

A

dividend yield

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15
Q

capital gains yield

A

percentage change in the price of stock

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16
Q

percentage change in the price of stock

A

capital gains yield

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17
Q

total yield =

A

(ending price - beginning price + cash flows) divided by beginning price

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18
Q

dividend yield =

A

total dividends received divided by beginning price of stock

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19
Q

capital gains yield =

A

(ending price - beginning price) divided by beginning price

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20
Q

current yield =

A

total interest payments received divided by beginning price of bond

21
Q

how do financial markets report yields

A

yields are reproted on an annualized basis.
-easier to compare different investments

22
Q

how are most interest rates quoted

A

most interest rates are quoted as an annual percentage rate (APR)

23
Q

how do you calculate average (mean) returns on investmetn?

A

ans depends on what question you want answered
- “What is the average annual rate you earned on this investment for a given year? (calculate arithmetic mean)
- what ist heaverage annual rate yur earned on this investment over an extended period of time? (mean return)

24
Q

what is the average annual rate you earned on this investment for a given year?

A

arithmetic mean rate
-tells you the best estimate of what you have earned in a single random year during the five years that you held the stock
(average annual rate doesn’t take compound interest into account so it will overestimate the average return for an extendng holdng period.

25
Q

what is the average annual rate you earned on this investment over an extended period of time

A

geomatric mean return
-done to take into account compound interest.

26
Q

how to use the geometric mean to calculate the geometric return (answer question of “What is the average annual rate you earned on an investment over an extended period of time?”

A

takes into account compounding over time.
1. add 1 to each of hte annual returns
2. multiply all fohte terms together
3. raise the product from the previous step to the power of one over the number of observations n - same as taking the nth root of the product
4. subtract one to get the geometric mean

27
Q

risk (in finance)

A

chance/probability of not earning your expected return on an investment. quantifying risk requires determining the uncertainty associated w/the expected return on an investment

28
Q

risk aversion

A

not the fear of risk but the unwillingness to accept it without adequate compensation

29
Q

why are newer younger stocks risker

A

younger stocks are considered risker b/c they lack a track record of returns against which to mesure the risks -unliked stocks like OBM or AT&T

30
Q

why are tech stocks riskier than average?

A

tech stocks are riskier b/c a new technological breakthrough can occur at any time -by the firm or a competitor

31
Q

4 phases of the business cycle

A

recession, expansion, boom, contraction
- all can occur within a 10 year period so you need to see what the stocks’ average returns have been duringthe past business cycles

32
Q

hight of the business cycle

A

booming (stage of business cycle)

33
Q

definition of risk in finance

A

risk is defined as the chance/probability of not earning your expected return on investment
-quantifying risk requires determining the uncertainty associated with the expected return on an investment

34
Q

risk in finance
- looking at investment on its own or well-diversified portfolio

A
  • stand alone risk if looking at an investment on its own
  • portfolio risk
    **it is good/necessary to understand the risks associated w/an investment when held on its own buthte relevant risk of an investment is the risk it asds to a diversified profile
35
Q

why is the relationship between risk and return positive?

A

risk aversion. want it to be workth it

36
Q

3 most common types of risk businesses face

A

business risk, financial risk, and portfolio risk

37
Q

EBIT

A

earnings before interest and taxes

38
Q

what is a firm’s value derived from

A

a firm’s value is derived from its expected future dividends and dividare paid from earnings

39
Q

business risk

A

uncertainty a firm faces with regard to its operating income (EBIT - earnings before interest and taxes)

40
Q

how can a business control or reduce uncertainty in net income

A

by controlling or reducing uncertainity in operating earnings

41
Q

4 things that affect the level of operating income

A

changes in sales revenue, cost of goods sold, operating expenses, and depreciation

42
Q

CV

A

coefficient of variation

43
Q

DOL

A

degree of operating leverage

44
Q

3 ways to analyze business risk and spot changes to business risk over time

A
  • calculate the coefficient of variation (CV) of EBIT over a period of time
  • calculate the CV of the operating margin over time
  • calculate the degree of operating leverage (DOL) over time
45
Q

what does the coefficient of variatino (CV) measure when applied to investments

A
  • measures risk per unit of return for hte variable beinganalyzed
  • a measure of rik NOT return
  • when comparing CVs for two different investments, smaller is better (minimizing risk)
46
Q

calculate coefficient of variation

A

standard devision ofhte variable divided by the mean (arthmetic average)
* best to use as many observations as possible (a standard deviation iwth 2-3 data points is misleading()

47
Q

calculate operating margin

A

= EBIT/REvenue

48
Q

operating leverage

A

measures the impact of changes in sales revenue on operating income.
- occurs b/c of he fixed costs in production processes

49
Q

how is degree of operating leverage (DOL) measured

A

)measured as the percent change in operating income divided by the perpcent change in sales revenue. thus, the metric requires 2 periods of data

MBA (3 decks)

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