CF Final Exam Notes Flash Cards

Question 1

Investment Ratio of Return

Answer 1

Expected Return / Risk = Investment Ratio of Return

Question 2

Beta Coefficient

Answer 2

Measures the assets returned sensitivity to the overall stock market return (S+P 500 Index Return)

Question 3

Beta = 1

Answer 3

The assets return tends to move in the same direction as the stock markets return and by the same percentage

Question 4

Beta = 2

Answer 4

The assets return tends to move in the same direction as the stock market but by twice as much

Question 5

Beta = 0.5

Answer 5

The assets return tends to move in the same direction as the stock markets return but by 0.5 as much

Question 6

Higher Beta

Answer 6

More Risk, More Return

Question 7

Lower Beta

Answer 7

Lower Risk, Lower Returns

Question 8

How to Measure Risk Using Past Data

Answer 8

• # of negative returns
• range of sample returns
• Standard Deviation of past returns

Question 9

Correlation Coefficient

Answer 9

Measures the degree and direction of linear association between two variables

Question 10

Low Correlation Coefficient

Answer 10

Higher benefit from diversification

Question 11

Why is Standard Deviation not the best measure of risk?

Answer 11

Standard deviation only go so far in the diversification of of a portfolio as the risk protection begins to decline as stock are diversified

Question 12

Actions to Raise Beta

Answer 12

• Buy “new” high beta stocks in the portfolio
• Finviz.com - Identify and - research ratios
• Sell low beta stocks currently in your portfolio
• Buy more high beta
  shares/stocks

Question 13

Actions to Raise Beta

Answer 13

• Buy new low beta stocks in the portfolio
• Sell high beta stocks in the portfolio
• Buy more shares in low beta stock we already own

Question 14

Sharpe Ratio

Answer 14

Average Return / Standard Deviation = Sharpe Ratio

Question 15

Expected return

Answer 15

Expected return = risk free rate + the beta * (expected return on the stock market - risk free rate)

Question 16

Market Risk Premium

Answer 16

Identifies how much can be expected to return for taking on a systematic risk

Question 17

Bear Market Cutoff

Answer 17

20%

Question 18

Options Contracts

Answer 18

Give the owner the right, but not the obligation, to do something up until the expiration date

Question 19

Call Options

Answer 19

Gives its owner the right, but not the obligation, to buy the underlying stock at a pre specified price in the contract through the expiration date (Call gives you the right to buy)

Question 20

Put Options

Answer 20

Gives its owner the right but not obligation to sell the stock at a pre specified price in the contract up until the expiration date

Question 21

Premium (Call options)

Answer 21

Price or value of a call option

Question 22

When buying an option what is the most the investor may lose?

Answer 22

The amount the investor originally paid for the option

Question 23

WACC

Answer 23

( % of firms assets financed with debt ) * (After tax cost of debt of the firm) + (% of the firms assets financed with equity) * (cost of equity) = WACC

Question 24

If the internal rate of return is higher than the required return (A or D)

Answer 24

Accept

Question 25

If the internal rate of return is lower than the required return (A or D)

Answer 25

Decline

Question 26

Why is the WACC not always the best measurement of risk?

Answer 26

- The firm may be underinvesting if they if they use the WACC as the discount always - using too high of a cutoff - The firms may over invest in products that do not hold value and have a high level of risk.

Question 27

What is Capital Budgeting?

Answer 27

A financial analysis of which projects the firm is considering, with the purpose to arrive at an accept or reject decision

Question 28

Independent Projects

Answer 28

If the projects are independent the manager can accept as many that satisfy the decision rule

Question 29

Mutually Exclusive Projects

Answer 29

If the projects are mutually exclusive, the manager can accept at most 1

Question 30

NPV = +1

Answer 30

(Accept, as it is greater than 0)

Question 31

NPV = 0

Answer 31

Accept

Question 32

NPV = -1

Answer 32

Decline, not earning the required rate of return

Question 33

Interpret a NPV Number Literally

Answer 33

Not only do the projects cash flows earn the required rate of return compounded annually over the life of the project, but it also creates an additional (NPV #) in value for the owners

Question 34

What is the Implication of Real Options?

Answer 34

If investors take on a project investors they can analyze how it will unfold

Question 35

Original NPV rule

Answer 35

IF the NPV is greater than or = to 0 accept, if the NPV is less than 0 reject

Question 36

Real Options NPV Rule

Answer 36

If the NPV + the value of real options is greater than to 0 accept, if the NPV + the value of real options is not over 0 then continue to reject

Question 37

You been asked to come up with the cash flows for the capital budgeting analysis, list 7 things your going to be thinking about during the analysis

Answer 37

- Initial cash outflow - Change in next working operating capital - How many units of the product will be sold - What price will the product be sold at - Fixed cost - Consider tax rate - If the project has an end date is any part of the process salvageable