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Question No: 01
Growth Stock and Value Stock: By growth stock the researcher mean to stock with high
P/E and P/B ratio, and low dividend payout ratio. The investors have high growth expectation
(relative to overall market) regarding these stocks. By value stock the researcher mean to stock
with low P/E and P/B ratio, and high dividend payout ratio. The investors have low growth
expectation (relative to overall market) regarding these stocks.
Relevance of Findings on the Investment: Investors who have preference for income
through value appreciation will like to make investment in growth stock. Investors who have
preference for constant income (through dividend) will like to make investment in growth stock.
Also, investors who have high growth expectation will like to make investment in growth stocks.
On the other hand, investors seek undervalued stocks in the market will like to make investment
in value stocks.
Question No: 02
Factors Examined by Fama and French that Explain the Stock’s Return: According to
Fama & French model, there are three factors that explain the stock return in market. These
include stock beta, size effect, and value effect.
Question No: 03
Measures of Risk Concluded by Fama and French in Explaining the Stock Return: The
capital assets pricing model (CAPM) only considers market risk (responsiveness of stock’s
volatility to market volatility) to explain the stock return. But the Fama-French model has
expanded CAPM by considering other risk factors to explain the stock return accurately. Other
risk factors considered in Fama-French model include size risk (incremental risk in portfolio
with small cap stocks), and value risk (incremental risk in portfolio with value stocks).
Question No: 04
CAPM Model: The capital assets pricing model (CAPM) explains the asset or security
return in consideration of systematic risk. Under this model, systematic risk (a measure of
responsiveness of the asset or security return to overall market return) is the only single factor of
asset or security return. The asset or security return is determined by adding the risk premium
(additional market return over risk free rate) with the risk free rate. Risk premium is the
compensation for systematic risk of asset or security.
Required Rate of Return (K) = Risk Free Rate + (Beta * Risk Premium)
Fama- French Model: CAPM is the brainchild of Fama-French model. Fama-French
model adds additional two risk factors – size risk and value risk besides systematic risk factor...