working of financial system

May 28th, 2015
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Abilene Christian University
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We typically get the appropriate Beta from our comparable companies (often the mean or median Beta). However before we can use this “industry” Beta we must first unlever the Beta of each of our comps. The Beta that we will get (say from Bloomberg or Barra) will be a levered Beta. Recall what Beta is: in simple terms, how risky a stock is relative to the market. Other things being equal, stocks of companies that have debt are somewhat more risky that stocks of companies without debt (or that have less debt). This is because even a small amount of debt increases the risk of bankruptcy and also because any obligation to pay interest represents funds that cannot be used for running and growing the business. In other words, debt reduces the flexibility of management which makes owning

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Definition of 'Risk':The chance that aninvestment's actualreturnwill bedifferentthan expected.Risk includes the possibility of losing some or all of the original investment.Different versions of riskare usually measured by calculating thestandard deviationof thehistorical returnsoraverage returnsof a specific investment. A high standard deviation indicates a high degree of risk.Many companies now allocate large amounts of money and time in developingrisk managementstrategies to help manage risks associated with their business and investment dealings. A key component of the risk management process is risk assessment, which involves the determination of the riskssurrounding a business or investment.A fundamental idea in finance is the relationship between risk and return. The greater the amount of risk thatan investoris willing to take on,the greater the potentialreturn.The reason for this is that investors needto be compensated fortaking onadditionalrisk.For example:A U.S.Treasury bondis considered to be one of the safest (risk-free) investments and, when compared to acorporate bond, provides a lowerrate of return. The reason for this is that acorporationis much more likely to gobankruptthan the U.S. government. Because the risk of investing in a corporate bond is higher, investors are offered a higher rate of return.Types of RiskUnfortunately, the concept of risk is not a simple concept in fina

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