Here are the estimated ROE distributions for Firms A, B, and C: Probability 0.1 0.2 0.4 0.2 0.1 Firm A: ROEA 0.0% 5.0% 10.0% 15.0% 20.0% Firm B: ROEB (2.0) 5.0 12.0 19.0 26.0 Firm C: ROEC (5.0) 5.0 15.0 25.0 35.0 Calculate the expected value and standard deviation for Firm C’s ROE. ROEA =10.0%, σA =5.5%; ROEB =12.0%, σB =7.7%. Discuss the relative riskiness of the three firms’ returns. (Assume that these distributions are expected to remain constant over time.) Now suppose all three firms have the same standard deviation of basic earning power (EBIT/Total Assets), σA = σB = σC =5.5%. What can we tell about the financial risk of each firm?
Here are the estimated ROE distributions for Firms A, B, and C: Probability 0.1 0.2 0.4 0.2 0.1 Firm A: ROEA 0.0% 5.0% 10.0% 15.0% 20.0% Firm B: ROEB (2.0) 5.0 12.0 19.0 26.0 Firm C: ROEC (5.0) 5.0 15.0 25.0 35.0 Calculate the expected value and standard deviation for Firm C’s ROE. ROEA =10.0%, σA =5.5%; ROEB =12.0%, σB =7.7%. Discuss the relative riskiness of the three firms’ returns. (Assume that these distributions are expected to remain constant over time.) Now suppose all three firms have the same standard deviation of basic earning power (EBIT/Total Assets), σA = σB = σC =5.5%. What can we tell about the financial risk of each firm?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Question
- Here are the estimated
ROE distributions for Firms A, B, and C:
|
|
Probability |
||||
|
|
0.1 |
0.2 |
0.4 |
0.2 |
0.1 |
|
Firm A: ROEA |
0.0% |
5.0% |
10.0% |
15.0% |
20.0% |
|
Firm B: ROEB |
(2.0) |
5.0 |
12.0 |
19.0 |
26.0 |
|
Firm C: ROEC |
(5.0) |
5.0 |
15.0 |
25.0 |
35.0 |
- Calculate the expected value and standard deviation for Firm C’s ROE. ROEA =10.0%, σA =5.5%; ROEB =12.0%, σB =7.7%.
- Discuss the relative riskiness of the three firms’ returns. (Assume that these distributions are expected to remain constant over time.)
- Now suppose all three firms have the same standard deviation of basic earning power (EBIT/Total Assets), σA = σB = σC =5.5%. What can we tell about the financial risk of each firm?
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