implicit in a project
•
What action are we going to take if a certain metric is reached/crossed
•
Option to expand a project with positive NPV
•
Option to abandon/scale-back a project with negative cash flows and profit
•
Option to wait/postponed
•
Strategic Options:
Options for future, related business products or strategies
•
•
Chapter 12: Lessons from Capital Market History
•
Simply, the required return depends on the level of risk with the investment. Higher
risk demands a higher required return
•
Two components of total return on investment: (1) Income component such as
cash payments, (2) capital gain/loss in value of asset
•
Total dollar return = Dividend Income + Capital Gains(or loss)
•
Total Cash if investment is sold = Initial Investment + Total Dollar Return
•
Percentage Return
= (Dividends paid at end of period + Change in Market
Value) /
•
Beginning Market Value
•
Capital Gains Yield
is the change in price in the year, divided by beginning price
•
Capital Gains Yield = (P
t+1
- P
t
) / P
t
•
Investment returns are often compared to what you would have earned if you help
portfolios in indices and other comparables such as
•
Canadian common stocks (S&P/TSX) - portfolio based on sample of largest
companies
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US common stocks - 500 largest US companies in $USD
•
TSX Venture stock - Small and emerging companies not meeting listings
requirements for S&P/TSX
•
Small stocks - small-cap Canadian stocks as combined by Nesbitt Burns
•
Long Bonds - High-quality, long-term corporate, provincial and Gov. of Canada
•
Canada Treasury Bills - Treasury bucks with three-month maturity
•
Arithmetic mean return
can be calculated by adding percentage values and
dividing by number of periods
•
“What was your return in an average year over a period”
•
Risk Premium:
Excess return required from an investment in a risky asset over a
risk-free investment
•
Average risk premium is the Arithmetic mean return subtracted by the Arithmetic
average return of a “risk-free” investment, such as Treasury Bills.
•
Treasury bills have no credit default risk, and not subject to interest rate risk since
they are 3-month terms.
•
Volatility of the markets is examines using
variance
and
standard deviation
•
Variance:
Average squared deviation between the actual return and average
return
•
Standard Deviation:
Positive square root of variance
•
To compute variance, find the difference between actual and average return for
each time period, square them, and sum the squares, divide by (n-1)
•
Normal distribution:
Symmetric, bell-shaped distribution that can be defined by
its mean and standard deviation
•
Value at risk (VaR):
Statistical measure of maximum loss based on based on
97.5% of the normal distribution. However, VaR likely underestimates the amount
of capital needed because it is based on assuming a normal distribution of returns
•
Lessons from capital market history: (1) Stocks have significant risk, (2)
diversification can help reduce risk
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•
Geometric average return:
Average compound return earned per year over a
multiyear period
•