Chapter_18 - Chapter 18 Chapter The Analysis of Equity Risk...

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Chapter 18 Chapter 18 The Analysis of Equity Risk The Analysis of Equity Risk and the Cost of Capital and the Cost of Capital
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Link to Previous Chapters This Chapter Link to Next Chapter Link to Web Page Chapter 3 reviewed standard beta technologies to measure the cost of capital. Chapter 13 distinguished operating risk and financing risk. This chapter analyzes the fundamental determinants of operating and financing risk in equity investing. It also introduces price risk and outlines ways to incorporate risk when valuing firms and trading in their shares. Chapter 19 analyzes the risk of firms’ debt. The book’s web site has more discussion of risk. What are the problems with standard beta technologies? What are the fundamental determinants of risk? What is price risk? How is risk incorporated in valuation? The Analysis of Equity Risk and the The Analysis of Equity Risk and the Cost of Capital Cost of Capital
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What you will learn from this What you will learn from this chapter chapter That precise measures of the cost of capital are difficult to calculate What risk is How business investment can yield extreme (high and low) returns How diversification reduces risk Problems with using the standard Capital Asset Pricing Model and other beta technologies The difference between fundamental risk and price risk The determinants of fundamental risk The determinants of price risk
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What you will learn from this What you will learn from this chapter (cont.) chapter (cont.) How fundamental analysis protects against price risk How pro forma analysis can be adapted to prepare value-at-risk profiles How fundamentals help to measure betas How the investor finesses the problem of not knowing the required return How to combine value-at-risk profiling and screening analysis
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The Nature of Risk The Nature of Risk Value is determined by expected payoffs discounted for risk Risk is determined by the likelihood of getting payoffs that are different from the expected payoff Risk is characterized by the set of possible outcomes that an investor faces and the probabilities of these outcomes: a payoff (or return) distribution
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Models of the Distribution of Returns: Models of the Distribution of Returns: The Normal Distribution The Normal Distribution -3 sd -2 sd -1 sd 0 sd 1 sd 2 sd 3 sd 68.26% 95.44% Panel A: The normal distribution With a normal distribution, there is a 68.26% probability that a return will be within one standard deviation of the mean and a 95.44% probability that a return will be within two standard deviations of the mean. The letters, sd, indicate standard deviation Probability
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Best and Worst Performers, 2004: Wall Best and Worst Performers, 2004: Wall Street Journal Shareholder Scorecard Street Journal Shareholder Scorecard The Best Performers The Worst Performers One Year Return, % Taser International 361.1% Agere System -55.1% Kmart Holding 313.2% Foundry Network -51.8% Chicago Mercantile Exch 218.5% Ciena -49.1% Autodesk 209.6% PMC-Sierra -44.0% Apple Computer 201.4% Synopsys -42.3%
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