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    Department of Management Sciences, National University of Modern Languages

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    Sheiry
    This document discusses the five fundamental factors that influence the risk premium of an investment: 1) business risk, 2) financial risk, 3) liquidity risk, 4) exchange rate risk, and 5) country/political risk. It also provides an example of calculating holding period return (HPR) and holding period yield (HPY) on an investment where 100 shares were bought for $34 per share and sold for $39 per share a year later, with a $1.50 dividend received. The HPR was calculated as 1.191 or 19.1% HPY.

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    Department of Management Sciences, National University of Modern Languages

    Uploaded by

    Sheiry
    37 views8 pages
    This document discusses the five fundamental factors that influence the risk premium of an investment: 1) business risk, 2) financial risk, 3) liquidity risk, 4) exchange rate risk, and 5) country/political risk. It also provides an example of calculating holding period return (HPR) and holding period yield (HPY) on an investment where 100 shares were bought for $34 per share and sold for $39 per share a year later, with a $1.50 dividend received. The HPR was calculated as 1.191 or 19.1% HPY.

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    IPM Assignment

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    This document discusses the five fundamental factors that influence the risk premium of an investment: 1) business risk, 2) financial risk, 3) liquidity risk, 4) exchange rate risk, and 5) country/political risk. It also provides an example of calculating holding period return (HPR) and holding period yield (HPY) on an investment where 100 shares were bought for $34 per share and sold for $39 per share a year later, with a $1.50 dividend received. The HPR was calculated as 1.191 or 19.1% HPY.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    37 views8 pages

    Department of Management Sciences, National University of Modern Languages

    Uploaded by

    Sheiry
    This document discusses the five fundamental factors that influence the risk premium of an investment: 1) business risk, 2) financial risk, 3) liquidity risk, 4) exchange rate risk, and 5) country/political risk. It also provides an example of calculating holding period return (HPR) and holding period yield (HPY) on an investment where 100 shares were bought for $34 per share and sold for $39 per share a year later, with a $1.50 dividend received. The HPR was calculated as 1.191 or 19.1% HPY.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 8

    Department of Management Sciences, National University of Modern

    Languages

    Assignment
    Submitted by:
    Shahraz Mushadi
    Roll NO: 31466
    Subject: IPM
    Submitted to: Mam Sabah
    Class: MBA (3.5)4th Evening
    Date: 25-04-2020
    Content
     Briefly discuss the five fundamental factors that influence the risk
    premium of an investment.
     On February 1, you bought 100 shares of stock in the ABC corporation for
    $34 per share, and a year later you sold it for $39 a share. During the
    year, you received a cash dividend of $1.50 a share. Compute your HPR
    and HPY on this investment.
    Briefly discuss the five fundamental factors that influence the risk premium of
    an investment.
    Risk Premium
    A risk-free investment was defined as one for which the investor is certain of the
    amount and timing of expected returns. The returns from most investments do
    not fit this pattern. An investor typically is not completely certain of the income to
    be received. Investments can range in uncertainty from basically risk-free
    securities, such as T-bills, to highly speculative investments, such as common stock
    of small companies engaged in high-risk enterprises.
    Investors require higher rates of return on investments if they perceive that there
    is any certainty about the expected rate of return. This increase in the required
    rate of return over the NRFR is the risk premium.

    Risk Premium = f (Business risk, Financial risk, Liquidity risk, Exchange rate risk,
    Country risk)
    Fundamental factors
    These following are the five fundamental factors that influence the risk premium
    of an investment
    1. Business risk
    2. Financial risk
    3. Liquidity risk
    4. Exchange rate risk
    5. Country(political) risk

    1. Business risk
    It is the uncertainty of income caused by the nature of a firm’s business. The less
    certain the income flows of the firm, the less certain the income flows of the
    investor. Therefore, the investor will demand a risk premium that is based on the
    uncertainty caused by the basic business of the firm.
    2. Financial risk
    It is the uncertainty introduced by the method by which the firm finance its
    investments. If a firm uses only common stock to finance investments, it incurs
    only business risk. If a firm borrows money to finance investments, it must pay
    fixed financing charges prior to providing income to the common stockholders, so
    the uncertainty of returns to the equity investor increases. This increase in
    uncertainty because of fixed-cost financing called financial risk or financial
    leverage, and it causes an increase in the stock’s risk premium.

    3. Liquidity risk
    It is the uncertainty introduced by the secondary market for an investment. When
    an investor acquires an asset, he or she expects that the investment will mature or
    that it will be saleable to someone else. In either case, the investor expects to be
    able to convert the security into cash and use the proceeds for current
    consumption or other investments. The more difficult it is to make this conversion
    to cash, the greater the liquidity risk.
    4. Exchange rate risk
    It is the uncertainty of returns to an investor who acquires securities denominated
    in a currency different from his or her own. The likelihood of incurring this risk is
    becoming greater as investors buy and sell assets around the world, as opposed to
    only assets within their own countries.
    5. Country(political) risk
    It is uncertainty of returns caused by the possibility of a major change in the
    political or economic environment of a country.
    Country risk refers to the risk of investing or lending in a country, arising from
    possible changes in the business environment that may adversely affect operating
    profits or the value of assets in the country.

    On February 1, you bought 100 shares of stock in the ABC corporation for $34
    per share, and a year later you sold it for $39 a share. During the year, you
    received a cash dividend of $1.50 a share. Compute your HPR and HPY on this
    investment.

    Ending value of investment (including Cash Flows)


    HPR =
    Beginning Value of Investment
    39+1.50
    = 34
    40.50
    = 34

    =1.191
    HPY=HPR-1
    = 1.191-1
    = .191
    = 19.1%

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