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Name: Wayne Jones
REVIEW QUESTIONS. ANSWERS BRIEFLY IN YOUR OWN WORDS.
(NOTE: IF YOU COPY DIRECTLY FROM THE TEXT, YOU WILL NOT RECEIVE
CREDIT.)
1. Explain how a percentage return is calculated. How would you calculate the arithmetic
average return.
Solution
Percentage return is computed by dividing profit or loss of an investment by its initial investment
price and then multiplied by 100.
π‘ƒπ‘’π‘Ÿπ‘π‘’π‘›π‘‘π‘Žπ‘”π‘’ π‘Ÿπ‘’π‘‘π‘’π‘Ÿπ‘› = (π‘π‘Ÿπ‘œπ‘“π‘–π‘‘/π‘™π‘œπ‘ π‘ )/(πΌπ‘›π‘–π‘‘π‘–π‘Žπ‘™ π‘–π‘›π‘£π‘’π‘ π‘‘π‘šπ‘’π‘›π‘‘ π‘π‘Ÿπ‘–π‘π‘’) βˆ— 100
Arithmetic average return is calculated by adding up the individual returns and then dividing by
number of periods.
2. What is meant by the term β€˜variance’? β€˜standard deviation’? Indicate how they are used
as measures of risk.
Solution
Both variance and standard deviation are measures of spread. They measure the amount of
dispersion of a given dataset. Variance is the average squared deviation of individual
observations from the mean. The square root of the variance is called standard deviation.
Variance and standard deviation are used to measure the volatility of the risks. A low standard
deviation or variance indicates low volatility, and high values show high volatility and hence
high risks.
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3. What is meant by the term β€˜coefficient of variation’? How is it used as a measure of risk?
Solution
The coefficient of variation measures the spread of data points in a data series from the mean. It
represents the ratio of standard deviation to mean. It is an essential statistic because it compares
the variation degree between data series. It helps measure risks because it shows the variability
of the dataset hence assisting the investors in understanding the volatility or risk. A low value of
the coefficient of variation indicates low risk, while a more significant value shows high risk.
4. What are the primary sources of business risk?
Solution
β€’ Per unit prices and costs of inputs
β€’ Competition
β€’ The overall economic climate
β€’ Demand , sale volumes and consumer preferences
β€’ Government regulations and policies.
5. What are sources of risk facing a firm which are reflected on its income statement?
Explain your answer.
Solution
Sources of risk that are reflected in the income statement are:-
β€’ Exchange rate risk
β€’ Business risk
β€’ Financial risk
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β€’ Purchasing power risk
β€’ Tax risk
β€’ Interest rate risk.
6. Suppose the U.S. dollar strengthens in the past year against other currencies. What
effect will that have on U.S. dollar revenues and expenses for a global firm
headquartered in the U.S.
Solution
Strengthening the U.S Dollar means that the cost of imports will go down, leaving more
disposable income to the American consumers. United States companies will import raw
materials from foreign companies at a lower cost of production and hence more production and
increased profits. The companies will increase their revenues and have less expenses due to low
production costs.
7. Explain the historical relationships between return and risk for common stocks versus
corporate bonds.
Solution
Return and risk refer to possible financial gain or loss experienced through security investment.
An investor with a profit on his shares is said to have a return on the investment. Risk denotes
the likelihood of an investor making a loss on the investment. An investor who chooses to invest
in a security with low risk is likely to have small returns. Contra-wise, an investor who invests in
high-risk security is expected to have higher returns. Returns obtained from an investment are
measured using real rate or nominal rate. Returns and risks are related such that higher risks
mean higher returns, and lower risks mean lower returns. Historically, corporate bonds earn
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lower returns due to their lower risks when compared to common stocks. Corporate bonds make
a fixed amount of income or regular periods, and during liquidation, corporate bonds are paid
first before common stocks due to their lower risks. Common stocks have higher returns because
they possess higher risks than bonds. They are more volatile and do not have regular payments.
This is because they have higher risks.
8. Explain what is meant by β€œmarket efficiency.” What are the characteristics of an
efficient market?
Solution
Market efficiency is the degree to which the market prices reflect all the available, pertinent
information. In an efficient market, all the information is already amalgamated into prices, and
thus there is no way of beating the market due to overvalued or undervalued available securities.
Characteristics of an efficient market are completeness, perfect, costless, and instant information
transmission.
9. What are the differences among the weak, semi-strong, and strong forms of the efficient
market hypothesis?
Solution
β€’ The weak market hypothesis suggests that current stock prices reflect all past prices data,
and there exists no form of technical analysis that can assist investors.
β€’ The semi-strong market hypothesis form suggests that due to public information being part
of the stock's current price, investors cannot use either fundamental or technical analysis
through the information that is not present to the public can assist the investors.
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β€’ The strong form of market hypothesis indicates that all information, private and public, is
accounted for in current prices of stocks, and no information type can benefit the investor
in the market.
10. What type of market efficiencyβ€”none, weak, semi-strong, or strongβ€”exists under each
of the following statements?
a) I know which stocks are going to rise in value by looking at their price changes over the
past two weeks. - Strong
b) Returns earned by company officers trading their own firm’s stock are no better than those
of other investors-None
c) If a firm announces lower-than-expected earnings, you know the price will fall over the next
quarter-Weak
d) By the time I heard the news about the dividend increase the stock had already risen by a
substantial amount- Semi-Strong
e) Whatever the stock market does in January, it will continue to move in that direction for the
rest of the year- None
f) As soon as the chairman of the Federal Reserve gives his testimony to Congress about
future monetary policy, interest rates rose and stock prices dropped-Weak
11. Define what is meant by a portfolio and describe how the expected return on a portfolio is
computed.
Solution
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A portfolio refers to set of various types of financial assets or instruments which involves bonds,
stocks, mutual funds, Cash, ETF etc. The expected return of a portfolio is computed by getting
the sum of the products of asset weights and expected return.
Return of portfolio=
βˆ‘
w
i
R
I
12. Explain the terms diversification and correlation in the context of forming portfolios.
Solution
Diversification refers to the strategy used in portfolios to manage risks. It is founded on the
premise that portfolios based on average have long-term returns and fewer chances of nay
holding assets or security. On the other hand, correlation refers to the movement of multiple
returns of the assets in a given direction. It denotes the relationship between various acquisitions
in the portfolio. Assets can be either negative or positive correlated or not correlated at all.
13. What is meant by the Capital Asset Pricing Model? Describe how it relates to expected
return and risk.
Solution
The capital Asset Pricing Model demonstrates the relationship between expected return and
systematic risks for assets or stocks. CAPM states that the expected returns of securities or
portfolios equal the price of risk-free securities and the risk premium. If the expected return is
not equal to the required return, the investor is asked to progress with the investment plan of the
assets.
14. Define the concept of β€œbeta” and describe what it measures.
Solution
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Beta refers to a numeric statistic that measures a stock's fluctuations to the overall stock market
variation. It is used to measure risk, and it is an integral part of the Capital Asset Pricing Model.
A company with a higher beta value has higher expected returns and more significant risks.

Unformatted Attachment Preview

Name: Wayne Jones REVIEW QUESTIONS. ANSWERS BRIEFLY IN YOUR OWN WORDS. (NOTE: IF YOU COPY DIRECTLY FROM THE TEXT, YOU WILL NOT RECEIVE CREDIT.) 1. Explain how a percentage return is calculated. How would you calculate the arithmetic average return. Solution Percentage return is computed by dividing profit or loss of an investment by its initial investment price and then multiplied by 100. π‘ƒπ‘’π‘Ÿπ‘π‘’π‘›π‘‘π‘Žπ‘”π‘’ π‘Ÿπ‘’π‘‘π‘’π‘Ÿπ‘› = (π‘π‘Ÿπ‘œπ‘“π‘–π‘‘/π‘™π‘œπ‘ π‘ )/(πΌπ‘›π‘–π‘‘π‘–π‘Žπ‘™ π‘–π‘›π‘£π‘’π‘ π‘‘π‘šπ‘’π‘›π‘‘ π‘π‘Ÿπ‘–π‘π‘’) βˆ— 100 Arithmetic average return is calculated by adding up the individual returns and then dividing by number of periods. 2. What is meant by the term β€˜variance’? β€˜standard deviation’? Indicate how they are used as measures of risk. Solution Both variance and standard deviation are measures of spread. They measure the amount of dispersion of a given dataset. Variance is the average squared deviation of individual observations from the mean. The square root of the variance is called standard deviation. Variance and standard deviation are used to measure the volatility of the risks. A low standard deviation or variance indicates low volatility, and high values show high volatility and hence high risks. 3. What is meant by the term β€˜coefficient of variation’? How is it used as a measure of risk? Solution The coefficient of variation measures the spread of data points in a data series from the mean. It represents the ratio of standard deviation to mean. It is an essential statistic because it compares the variation degree between data series. It helps measure risks because it shows the variability of the dataset hence assisting the investors in understanding the volatility or risk. A low value of the coefficient of variation indicates low risk, while a more significant value shows high risk. 4. What are the primary sources of business risk? Solution β€’ Per unit prices and costs of inputs β€’ Competition β€’ The overall economic climate β€’ Demand , sale volumes and consumer preferences β€’ Government regulations and policies. 5. What are sources of risk facing a firm which are reflected on its income statement? Explain your answer. Solution Sources of risk that are reflected in the income statement are:β€’ Exchange rate risk β€’ Business risk β€’ Financial risk 6. β€’ Purchasing power risk β€’ Tax risk β€’ Interest rate risk. Suppose the U.S. dollar strengthens in the past year against other currencies. What effect will that have on U.S. dollar revenues and expenses for a global firm headquartered in the U.S. Solution Strengthening the U.S Dollar means that the cost of imports will go down, leaving more disposable income to the American consumers. United States companies will import raw materials from foreign companies at a lower cost of production and hence more production and increased profits. The companies will increase their revenues and have less expenses due to low production costs. 7. Explain the historical relationships between return and risk for common stocks versus corporate bonds. Solution Return and risk refer to possible financial gain or loss experienced through security investment. An investor with a profit on his shares is said to have a return on the investment. Risk denotes the likelihood of an investor making a loss on the investment. An investor who chooses to invest in a security with low risk is likely to have small returns. Contra-wise, an investor who invests in high-risk security is expected to have higher returns. Returns obtained from an investment are measured using real rate or nominal rate. Returns and risks are related such that higher risks mean higher returns, and lower risks mean lower returns. Historically, corporate bonds earn lower returns due to their lower risks when compared to common stocks. Corporate bonds make a fixed amount of income or regular periods, and during liquidation, corporate bonds are paid first before common stocks due to their lower risks. Common stocks have higher returns because they possess higher risks than bonds. They are more volatile and do not have regular payments. This is because they have higher risks. 8. Explain what is meant by β€œmarket efficiency.” What are the characteristics of an efficient market? Solution Market efficiency is the degree to which the market prices reflect all the available, pertinent information. In an efficient market, all the information is already amalgamated into prices, and thus there is no way of beating the market due to overvalued or undervalued available securities. Characteristics of an efficient market are completeness, perfect, costless, and instant information transmission. 9. What are the differences among the weak, semi-strong, and strong forms of the efficient market hypothesis? Solution β€’ The weak market hypothesis suggests that current stock prices reflect all past prices data, and there exists no form of technical analysis that can assist investors. β€’ The semi-strong market hypothesis form suggests that due to public information being part of the stock's current price, investors cannot use either fundamental or technical analysis through the information that is not present to the public can assist the investors. β€’ The strong form of market hypothesis indicates that all information, private and public, is accounted for in current prices of stocks, and no information type can benefit the investor in the market. 10. What type of market efficiencyβ€”none, weak, semi-strong, or strongβ€”exists under each of the following statements? a) I know which stocks are going to rise in value by looking at their price changes over the past two weeks. - Strong b) Returns earned by company officers trading their own firm’s stock are no better than those of other investors-None c) If a firm announces lower-than-expected earnings, you know the price will fall over the next quarter-Weak d) By the time I heard the news about the dividend increase the stock had already risen by a substantial amount- Semi-Strong e) Whatever the stock market does in January, it will continue to move in that direction for the rest of the year- None f) As soon as the chairman of the Federal Reserve gives his testimony to Congress about future monetary policy, interest rates rose and stock prices dropped-Weak 11. Define what is meant by a portfolio and describe how the expected return on a portfolio is computed. Solution A portfolio refers to set of various types of financial assets or instruments which involves bonds, stocks, mutual funds, Cash, ETF etc. The expected return of a portfolio is computed by getting the sum of the products of asset weights and expected return. Return of portfolio=βˆ‘ wi R I 12. Explain the terms diversification and correlation in the context of forming portfolios. Solution Diversification refers to the strategy used in portfolios to manage risks. It is founded on the premise that portfolios based on average have long-term returns and fewer chances of nay holding assets or security. On the other hand, correlation refers to the movement of multiple returns of the assets in a given direction. It denotes the relationship between various acquisitions in the portfolio. Assets can be either negative or positive correlated or not correlated at all. 13. What is meant by the Capital Asset Pricing Model? Describe how it relates to expected return and risk. Solution The capital Asset Pricing Model demonstrates the relationship between expected return and systematic risks for assets or stocks. CAPM states that the expected returns of securities or portfolios equal the price of risk-free securities and the risk premium. If the expected return is not equal to the required return, the investor is asked to progress with the investment plan of the assets. 14. Define the concept of β€œbeta” and describe what it measures. Solution Beta refers to a numeric statistic that measures a stock's fluctuations to the overall stock market variation. It is used to measure risk, and it is an integral part of the Capital Asset Pricing Model. A company with a higher beta value has higher expected returns and more significant risks. Name: Description: ...
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