Week 3

Question 1

risk & being a manager

Answer 1

-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

Question 2

what must you calculate for any risky decision your firm makes

Answer 2

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

Question 3

what type of relationship is between risk & return

Answer 3

direct/positive relationship between perceived risk & required return

Question 4

what type of risk is between value & discount rate

Answer 4

inverse

Question 5

what is used to value the firm’s common shares

Answer 5

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

Question 6

how is percentage return (yield) on an investment measured

Answer 6

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

Question 7

what is the cash flow for stocks during the year

Answer 7

dividends for stock

Question 8

what does stock pay

Answer 8

dividends

Question 9

what is the cash flow for bonds paid throughout the year

Answer 9

interest payments for bonds

Question 10

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

Answer 10

they means percentage returns, not dollar returns

Question 11

what does percentage returns indicate

Answer 11

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)

Question 12

calculate total return for stocks

Answer 12

total return = dividend yield and capital gains yield

Question 13

dividend yield

Answer 13

percentage return from dividends

Question 14

percentage return from dividends

Answer 14

dividend yield

Question 15

capital gains yield

Answer 15

percentage change in the price of stock

Question 16

percentage change in the price of stock

Answer 16

capital gains yield

Question 17

total yield =

Answer 17

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

Question 18

dividend yield =

Answer 18

total dividends received divided by beginning price of stock

Question 19

capital gains yield =

Answer 19

(ending price - beginning price) divided by beginning price

Question 20

current yield =

Answer 20

total interest payments received divided by beginning price of bond

Question 21

how do financial markets report yields

Answer 21

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

Question 22

how are most interest rates quoted

Answer 22

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

Question 23

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

Answer 23

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)

Question 24

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

Answer 24

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.

Question 25

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

Answer 25

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

Question 26

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?"

Answer 26

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

Question 27

risk (in finance)

Answer 27

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

Question 28

risk aversion

Answer 28

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

Question 29

why are newer younger stocks risker

Answer 29

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

Question 30

why are tech stocks riskier than average?

Answer 30

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

Question 31

4 phases of the business cycle

Answer 31

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

Question 32

hight of the business cycle

Answer 32

booming (stage of business cycle)

Question 33

definition of risk in finance

Answer 33

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

Question 34

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

Answer 34

- 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

Question 35

why is the relationship between risk and return positive?

Answer 35

risk aversion. want it to be workth it

Question 36

3 most common types of risk businesses face

Answer 36

business risk, financial risk, and portfolio risk

Question 37

EBIT

Answer 37

earnings before interest and taxes

Question 38

what is a firm's value derived from

Answer 38

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

Question 39

business risk

Answer 39

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

Question 40

how can a business control or reduce uncertainty in net income

Answer 40

by controlling or reducing uncertainity in operating earnings

Question 41

4 things that affect the level of operating income

Answer 41

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

Question 42

CV

Answer 42

coefficient of variation

Question 43

DOL

Answer 43

degree of operating leverage

Question 44

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

Answer 44

- 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

Question 45

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

Answer 45

- 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)

Question 46

calculate coefficient of variation

Answer 46

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()

Question 47

calculate operating margin

Answer 47

= EBIT/REvenue

Question 48

operating leverage

Answer 48

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

Question 49

how is degree of operating leverage (DOL) measured

Answer 49

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