Week 2

Question 1

What is a definition of cost of capital?

Answer 1

Opportunity costs of equity investors and debt suppliers

Question 2

How to come to the cost of equity?

Answer 2

CAPM method

Question 3

How to come to the cost of debt?

Answer 3

YTM (bonds outstanding) & spread approach (add spread to risk-free rate)

Question 4

Name the two types of risk of investments

Answer 4

1. non-systematic risk: firm specific risk, can be eliminated through diversification
2. systematic risk: affects entire economy. (higher systematic risk –> higher expected return)

Question 5

Give the formula of CAPM

Answer 5

CAPM = E(Ri) = Rf + Bi* (Rm - Rf)

Question 6

According to research, how much of the stocks should be boycotted to have a significant effect?

Answer 6

10-20% of the stocks

Question 7

What does a high cost of capital indicate?

Answer 7

That investors are wiling to pay less for new equity

Question 8

What does the paper of Hong and Kacperczyk (2009) tells us about sin stocks?

Answer 8

Sin stocks are traded at lower prices + give higher expected returns which cannot be explained by CAPM.

Sin stocks have less institutional ownership (less held by pension funds, banks etc.)

Sin stocks give an abnormal return & higher cost of equity than CAPM predicts –> equity financing is expensive