Corporate Finance TMA2 - Result.docx - Question 1 a The three examples and broad categories of financial assets available in Malaysia’s financial

Corporate Finance TMA2 - Result.docx - Question 1 a The...

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Question 1 a. The three examples and broad categories of financial assets available in Malaysia’s financial system are as follows: - Broad Categories Examples 1. Equity 1. Common stock 2. Preferred stock 3. Warrants 2. Security 1. Government bonds 2. Corporate bonds 3. Debentures 3. Money market instruments 1. Fixed Deposit 2. Treasury bills 3. Commercial papers b. The different between unsystematic risk and systematic risk: i. Unsystematic risk (diversifiable risk) 1
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Unsystematic risk is associated with the risk of individual asset based on the company’s performance. The risk normally is referring to the firm specific risk that can be reduced using the diversification process, i.e. diversify business into different areas / country to reduce their business risk. Unsystematic risk can further be categorized as business risks (uncertainty of business operation) and financial risks (the wrong financing method used by the company). The examples of the risks are: - Examples 1- The failure of company to successfully market its product Example 2 – The financial fraud in the company which may reduce return of the company. ii. Systematic risk (non-diversifiable risk) Systematic risk is unable to be reduced through the diversification process as it is including the risks such as inflation, change in interest rate, economic situation, reinvestment risk, fluctuations in security prices and etc. Systematic risk can be further categorized into 5 categories as follows: - i. Market risk associated with the movement of stock prices For example, major natural disaster, recession, political turmoil, etc. ii. Exchange rate risk associated with the fluctuations in the exchange rate market 2
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For example, currency risk will reduce the profit of the firms when it is converted back to the home country currency). iii. Reinvestment risk associated with reinvesting the funds at a lower return. For example, the yield to maturity of a bond may be affected by the fluctuation of interest rate. iv. Interest rate risk associated with the fluctuation in interest rates For example, fluctuation of the interest rates. v. Inflation risk associated with the purchasing power. For example, decline in value of securities cash flow due to inflation. Question 2 3
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Ali Baba Apple Index model regression estimates 3.5% + 1.4 (r m r f ) 3.5% + 2.1 (r m – r f ) Standard deviation on excess return 16.0% 23.4% Given that: r m = 14% and r f = 3.5% a. Sharpe measure Formula= Index Model Regressionestimates Standard Deviationonexcessreturn Ali Baba Apple 3.5%
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