Ch 6 Slide Show

Ch 6 Slide Show - CHAPTER6 Risk,Return,andtheCapital...

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1 CHAPTER 6 Risk, Return, and the Capital  Asset Pricing Model
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2 Topics in Chapter Basic return concepts Basic risk concepts Stand-alone risk Portfolio (market) risk Risk and return: CAPM/SML
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Value =                         +                         +     + FCF 1 FCF 2 FCF (1 + WACC) 1 (1 + WACC) (1 + WACC) 2 Free cash flow (FCF) Market interest rates Firm’s business risk Market risk aversion Firm’s debt/equity mix Cost of debt Cost of equity Weighted average cost of capital (WACC) Net operating profit after taxes Required investments in operating capital = Determinants of Intrinsic Value: The Cost of Equity ...
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4 What are investment returns? Investment returns measure the  financial results of an investment. Returns may be historical or  prospective (anticipated). Returns can be expressed in: Dollar terms. Percentage terms. 
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5 An investment costs $1,000 and is  sold after 1 year for $1,100. Dollar return: Percentage return: $ Received  -  $ Invested     $1,100      -   $1,000       = $100. $ Return/$ Invested       $100/$1,000        = 0.10 = 10%.
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6 What is investment risk? Typically, investment returns are not  known with certainty. Investment risk pertains to the  probability of earning a return less than  that expected. The greater the chance of a return far  below the expected return, the greater  the risk.
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7 Probability Distribution: Which  stock is riskier?  Why? -30 -15 0 15 30 45 60 Returns (% ) Stock A Stock B
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8 Consider the Following Investment Alternatives Econ. Prob. T-Bill Alta Repo Am F. MP Bust  0.10 8.0% -22.0%   28.0%   10.0% -13.0% Below avg.  0.20 8.0   -2.0   14.7 -10.0   1.0 Avg.  0.40 8.0   20.0     0.0   7.0   15.0 Above avg.  0.20  8.0   35.0 -10.0   45.0   29.0 Boom  0.10  8.0   50.0 -20.0   30.0   43.0  1.00
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9 What is unique about the T-bill  return? The T-bill will return 8% regardless of  the state of the economy. Is the T-bill riskless?  Explain.
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10 Alta Inds. and Repo Men vs.  the Economy Alta Inds. moves with the economy, so  it is positively correlated with the  economy.  This is the typical situation. Repo Men moves counter to the  economy.  Such negative correlation is  unusual.
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11 Calculate the expected rate of  return on each alternative. r = expected rate of return. r Alta  = 0.10(-22%) + 0.20(-2%)  + 0.40(20%) + 0.20(35%)  + 0.10(50%) = 17.4%. ^ ^ n r =    ^ i=1 r i P i .
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12 Alta has the highest rate of  return. Does that make it best? ^ r Alta    17.4% Market 15.0 Am. Foam 13.8 T-bill   8.0 Repo Men   1.7
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What is the standard deviation of returns for each alternative? σ
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Ch 6 Slide Show - CHAPTER6 Risk,Return,andtheCapital...

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