CH6

Question 1

Two of the most important factors to consider in investment decisions

Answer 1

1. Expected return
2. Risk of the investment

Question 2

disadvantages of single period return

Answer 2

Does not take into consideration the time value of money.

Question 3

internal rate of return equal to

Answer 3

present price of the share.

Question 4

The two categories risk can be divided into:

Answer 4

1. Systematic risk
2. Non-systematic risk

Question 5

Systematic risk

Answer 5

Risks that are a result of changes in the total economy.

Question 6

Types of systematic risks (5 risks)

Answer 6

1. Interest rate risk
2. Cyclical risk
3. Inflation risk
4. Exchange rate risk
5. Market risk

Question 7

Non- systematic risk

Answer 7

Risks that result from the nature of its activities. ( the business’s activities)

Question 8

Types of non-systematic risks (3 risks)

Answer 8

1. Operating risk
2. Financial risk
3. Industry risk
4. Other risk factors

Question 9

interest rates and investments have an inverse relationship.

If interest rates increase..

Answer 9

Price of shares will decreases.

Question 10

FIS

Answer 10

Fixed income securities.

Question 11

How does higher interest rates affect FIS

Answer 11

Increases demand for FIS, since they offer a higher interest rate.

Question 12

how to reduce the interest rate risk of an investment in securities

Answer 12

1. buy securities with a short remaining term.
2. Consider changes in CPI to predict interest rate changes.

Question 13

cyclical risk

Answer 13

probability that returns will be negatively influenced by changes in the economic cycle.

Question 14

Methods to reduce cyclical risk

Answer 14

1. Diversification over time
2. Diversification between different types of investments
3. Timing

Question 15

How should investors time the purchasing and selling of shares

Answer 15

purchases shares when the market is preforming poorly. Sell when the market is doing well( and prices are increasing)

Question 16

inflations affects these investments most

Answer 16

1. fixed income securities
2. savings accounts
   3 mortages

Question 17

approaches to hedge investments against inflation risk

Answer 17

1. International diversification
2. Balanced diversified portfolio
3. Timing
4. Inflation linked securities

Question 18

exchange rate risk

Answer 18

uncertainty regarding returns for investors that are exposed to foreign securities.

Question 19

the more volatile the exchange rate between two countries

Answer 19

The higher the exchange rate risk the investor is exposed to.

Question 20

how can investors protect themselves from exchange rate risk

Answer 20

1. Exchange rate recover
2. Thorough analysis of company
3. International diversification

Question 21

Exchange rate cover

Answer 21

-provided by financial institutions
- Bargain on fixed exchange rate when receiving investment revenue, therefore not exposed to unfavorable exchange rate movements.

Question 22

intrinsic value of a share

Answer 22

the value of the share according to the assets and liabilities of the company.

Question 23

how to determine if a share is under/over valued

Answer 23

compare the intrinsic value of the share with its market price.

Question 23

Market risk

Answer 23

probability that the market price of an investment will differ from its intrinsic value due to irrational investor behavior.

Question 24

strategies to protect oneself against market risk

Answer 24

1. Timing 2. Longer investment term 3. Investment diversification 4. Thorough analysis of the share.

Question 25

What happens if an enterprise uses debt capital in its capital structure

Answer 25

it can lead to an increase in the instability of the return on equity and earnings per share.

Question 26

positive financial leverage

Answer 26

cost of debt capital is less than the enterprises return on total assets

Question 27

negative financial leverage

Answer 27

cost of debt capital is higher than total return on total assets

Question 28

financial leverage factor

Answer 28

determines if positive or negative financial leverage is experienced.

Question 29

financial leverage is comparing

Answer 29

debt capital with return on total assets.

Question 30

For financial leverage a value > 1 indicates

Answer 30

positive financial leverage

Question 31

For financial leverage a value = 1 indicates

Answer 31

no financial leverage

Question 32

For financial leverage a value < 1 indicates

Answer 32

negative financial leverage

Question 33

considering these factors decreases exposure to financial risk

Answer 33

1. Analysis of an enterprises capital structure 2. Market interest rates

Question 34

Industry risks

Answer 34

Risks that are limited to specific industries

Question 35

Beta of a share

Answer 35

provides an indication of the share prices sensitivity relative to the prices of other shares in a specific market.

Question 36

System used to calculate the value for shares of a company or a portfolio of shares relatively quickly

Answer 36

The Barra system

Question 37

Beta of a share > 1

Answer 37

share is more sensitive than the market

Question 38

Beta of share < 1

Answer 38

Share is less sensitive than the market

Question 39

beta of share = 1

Answer 39

share price moves together with the market

Question 40

When shares are highly sensitive if market yields change

Answer 40

share exhibit large price differences

Question 41

When are are not sensitive

Answer 41

smaller changes in share price.