Question

1. What are the key components of return? Explain each component.


2. Name five sources of risk which investors may face.


3. Define systematic risk and explain how it differs from nonsystematic risk?


4. List the three types of systematic risk. Explain.


5. what is the difference between business and financial risk?


6. Match the following words and phrases to the definitions below:
1) Market risk
2) Liquidity risk
3) political risk

a) That portion of an asset’s total risk caused by discounts and selling commissions that must be given up to sell an asset quickly.
b) Arises because alternating bull and bear market conditions tend to affect all securities systematically.
c) That portion of an asset’s total variability of return caused by changes in the political environment.

TRUE/ FALSE
7. By investing in different securities, an investor can lower his exposure to risk.

8. The greater the dispersion of possible returns, the riskier is the investment.

9. Beta is a measurement of the relationship between a security's returns and the general market's returns.

10. Beta is a measure of systematic risk.






PROBLEMS
1.The Quinn’s company had the following annual return over the past five years:

Year Return
2013 10%
2014 -5
2015 14
2016 -6
2017 20

Determine Quinn’s average return and standard deviation of returns over the past 5 years.


2. Mr.Ali wants to buy Ant company stock which is currently selling at OMR 60 without dividend payment. There is equal probability for the Ant stock to be sold at OMR 65 and OMR 80 during the next year. What is the expected return and risk if 300 shares are bought?

Answer 1

1. What are the key components of return? Explain each component

Cash flows :

• Relevant
• Incremental cash flows
  • Opportunity costs - This is the benefit foregone by not chosing another investment by sacrificing for this investment
  • Side effects like cannibalism and erosion - If any product is increased and customers are less interested in already existing customers, then that is called as cannibalism. Erorison is gradual loss of existing product

Taxes : Investors want incremental after-tax cash flows.
Inflation : Rate which is added to an investment for adjusting future inflation

2. Name five sources of risk which investors may face.

Market risk - It is affiliated with market returns, also known as systemic risk. Macroeconomic factors like interest rate, currencies, politics, recessions, inflation are included in these.

Specific risk - This is not affiliated with market returns, also knon as unsystemic risk. Example, an assets value can be dropped because of bad management

Volatility risk - This is the risk about the size of changes in a security's value.

Reinvestment risk - If we reinvest in a bond of which interest rate is less than what the maturity bond is paying when you bought initially.

Default Risk - this is the risk when a borrower is unable to pay back debts or bills

3. Define systematic risk and explain how it differs from nonsystematic risk?

Systemic risk - It is affiliated with market returns, also known as market risk. Macroeconomic factors like interest rate, currencies, politics, recessions, inflation are included in these. This is less over long periods of time than short periods of time. This is for entire market segment, occurs due to macroeconomic factors  like interest rate, currencies, politics, recessions, inflation are included in these

Non-systemic risk - This is also known as specific risk meaning the type of risk comes with the comapny or industry invetsed in.These arise due to micro economic factors . Can be divided into business and finacial risks.

4. List the three types of systematic risk. Explain

Interest risk - If interest rates shoot up, bond price will decline. And they do also affect economic activity and borrowing costs

Market risk - t is affiliated with market returns, also known as systemic risk. Macroeconomic factors like interest rate, currencies, politics, recessions, inflation are included in these.

Inflation risk - higher the prices lower is the purchase power of investments. If investment returns don’t exceed inflation indicates one is losing purchasing power

5. what is the difference between business and financial risk?

Financial risk is the baility to manage one's debt and financial leverage rather than the operational risk of making the company a profitable enterprise.It is concerned with the costs of financing

Business risk is the one'sability to generate sufficient revenue to cover one's operational expenses.It is concerned with all the other expenses (include salaries, production costs, facility rent, and office and administrative expenses)a business must cover to remain operational and functioning