CorpF Revise
CorpF Revise
CorpF Revise
Concept Questions
Standard Deviation is the measurement of the uncertainty in the distribution of possible
outcomes.
The bigger the Standard Deviation, the bigger the uncertainty, therefore, the bigger the
risk.
For the market: Beta = 1
Covariance measures the direction of a relationship between two variables, while correlation
measures the strength of that relationship.
12.1a What are the two parts of total return?
Income component + K gain/loss.
12.1b Why are unrealized capital gains or losses included in the calculation of returns?
Unrealized capital gains or losses included in the calculation of returns because indirectly.
unrealized portion is also a gain to the company on a particular investment, so to get accurate
returns we will include both unrealized capital gains or losses.
12.1c What is the difference between a dollar return and a percentage return? Why are
percentage returns more convenient?
more convenient to summarize information about returns in percentage terms, rather than
dollar terms, because that way your return doesn’t depend on how much you actually invest
=>>How much do we get for each dollar we invest?
12.2b Why doesn’t everyone just buy small stocks as investments?
Small-cap company has a wider range of risk distribution. Risk averse investor would not favor
the volatility of small-cap stock while risk lovers are compensated with higher return probability
12.3a What do we mean by excess return and risk premium?
risk premium: the difference between the average return earned and risk free rate.
= average return - risk free rate
“excess” return: the additional return we earn by moving from a relatively risk-free investment
to a risky one
= return on S - risk free rate
12.3b What was the real (as opposed to nominal) risk premium on the common stock portfolio?
The real risk premium is the expected rate on the common stock portfolio over the life of the
portfolio.
12.3c What was the nominal risk premium on corporate bonds? The real risk premium?
Real i rate = (1+nominal i rate)/(1+inflation rate) - 1
The nominal risk premium is the difference between real risk premium on corporate bond and
the historical nominal rate.
12.3d What is the first lesson from capital market history?
every risky asset, will earn a risk premium. There is a reward for taking risk, reward is the risk
premium.
geometric average return earned per year on average, compounded annually
= [(1+r1)+(1+r2)+.......+(1+rn)]^(1/n) - 1
arithmetic average return what you earned in a typical year
= Total Value of the Return/Total Nu of Returns
arithmetic average return is probably too high for longer periods and the geometric average is
probably too low for shorter periods
if you are using averages calculated over a long period to forecast up to a decade or so into the
future, arithmetic average.
doing very long forecasts covering many decades, use the geometric average.
CHAPTER 5 Financial Leverage and Capital Structure
Cost of Ordinary Shares: Internal Funding: RE, self-generated, cheapest
External Funding: E, D
Pecking order: RE, D, E.
17.5b What is a dividend clientele? All things considered, would you expect a risky firm with
significant but highly uncertain growth prospects to have a low or high dividend payout?
The clientele effect argument states that different groups of investors desire different levels of
dividends. When a firm chooses a particular dividend policy, the only effect is to attract a
particular clientele. If a firm changes its dividend policy, then it just attracts a different clientele.
17.8a What is the effect of a stock split on stockholder wealth?
17.8b How does the accounting treatment of a stock split differ from that used with a small
stock dividend?