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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.
[S1] If an individual stock's beta is higher than 1, that stock is riskier than the market. [S2] In determining the estimated
a. both are true
b. both are false
c. S1 is true
d. S2 is true
Step by step
Solved in 2 steps
- If the intrinsic value of a stock is greater than its market value, which of the following is a reasonable conclusion? O 1. The stock offers a high dividend payout ratio. 02 The market is overvaluing the stock. O 3. The stock has a low level of risk. O 4. The market is undervaluing the stocka. What is the relationship between the expected return of a stock and its fair expected return? When is a stock underpriced, overpriced, or fairly priced? b. Explain what happens to the firm’s cost of equity, cost of debt, and cost of capital when the firm increases the amount of debt in its capital structure. Assume all Modigliani and Miller assumptions hold and that there are no taxes. c. How can we use the internal rate of return to evaluate whether we should pursue a specific project? Should we pursue a project when the cost of capital is higher than the internal rate of return?Which of the following is true? a. Beta of a stock cannot be negative b. SML is an acronym for Stock Market Line c. Holding multiple stocks from the same industry is meaningful diversification d. Undiversifiable risk is known as the systematic risk
- Q1 .In an investment market , understanding the concept of undervalued and overvalued stock is very important . hence , a prudent investor must have good knowledge about beta, market rate of return and risk free rate of return a) Being an investor , critically analyse the conditions of undervalud and overvalued stockIf the fair value of a stock is more than its market value, which of the following is a reasonable conclusion? a. The stock has a low level of risk b. The stock offers a high dividend payout ratio c. The market is undervaluing the stock d. The market is overvaluing the stockWhich of the following statements is correct? A. The optimal dividend policy is the one that satisfies management, not shareholders. B. The use of debt financing has no effect on earnings per share (EPS) or stock price. C. Stock price is dependent on the projected EPS and the use of debt, but not on the timing of the earnings stream. D. The riskiness of projected EPS can impact the firm's value. E. Dlvidend policy is one aspect of the firm's financial policy that is determined solely by the shareholders. Reset Selection
- Explain the effect of D/E on asset returns, equity returns (assuming that cost of debt is not affected), asset beta and equity beta (assuming that debt beta is zero). Should an investor choose to invest in a stock of a company with high or low D/E, or why expected returns on these stocks are equivalent, although they are not equal?2. What are flotation costs? 3. How is cost of common equity computed for no growth stock? for constant growth stock? 4.What is a dividend yield? 5. Define the following terms used in Capital Asset Pricing Model (CAPM) to compute for cost of equity: a. Risk-free rate b. Stock's Beta Coefficient C. Market risk premium 6. How is cost of equity under Bond Yield Plus Risk Premium Approach computed? 7. How is weighted average cost of capital (WACC) computed?1. The P/E method of valuation is appropriate for Value investors. What does it mean if the P/E ratio is higher than the industry average? Should you buy the stock or not? 2. Why is EPS an inferior measure compared to cash flow? In what way is it a superior measure for stock investing compared to cash flow analysis?
- Q1 .In an investment market , understanding the concept of undervalued and overvalued stock is very important . hence , a prudent investor must have good knowledge about beta, market rate of return and risk free rate of return b) Give a graphical example to present the positioning of- systematic risk- risk free rate of return - mareket rate of return- risk premium3) The return on a stock, in a factor model, in a given period will be related to A) firm-specific events. B) macroeconomic events. C) the error term. D) both firm-specific events and macroeconomic events. E) neither firm-specific events nor macroeconomic events. 4) Assume the index model is valid, what inputs will be required to determine covariance between two assets? A) βk B) βL C) σM D) all of the options E) None of the options are correct.Choose the correct answer with justification.Which statement is false regarding the Capital Asset Pricing Model? A. The beta coefficient of a stock is constant. B. The risk free rate is usually based on the treasury bill yield. C. Market risk premium is the difference between market return and the risk free rate. D. The cost of retained earnings is equal to the cost of new shares issued.