Question

1. Explain the difference between a stock's expected rate of return, required rate of return and its' realized after-the-fact return?

2. What is the beta of a stock measuring? Why is it argued that beta is the best measure of a stock's risk?

3. Overall, what are some important concepts for individual investors to consider when evaluating the risk and returns of various investments?

Answer 1

1)

An expected rate of return is the return on investment which a firm expects to collect from its investment. This rate is calculated based on probability. Expected rate of return is what a firm actually plans to make from any investment proposal.

The Required Rate of Return is the minimum possible rate that a firm has to earn from its investment. For example if we borrow a loan from a financial institute at 8% interest rate and the same fund we invested in a project. So the return from the project should be above 8%. This is called required rate or return.

Realized yield is the actual return earned from an investment during the holding period for an investment. Dividends declared on shares or interest payments on debt are some examples of realized after the fact return.

2)

Beta is a risk measurement tool associated with a security investment. It measures stock's volatility in relation to the market index. For example, the S&P 500 Index, has a beta of 1.0, and individual stocks are ranked according to how much they vary from the market. A stock that changes more than the market index during a time has a beta above 1.0. If a stock changes less than the market, the stock's beta is less than 1.0. High-beta securities are ranked to be risky securities and low-beta stocks are less risky.

Some argue that beta does not give enough information about the fundamentals of a company and its value for stock selections. But Beta is probably a better indicator of risk measurement. Moreover, there are variations on beta depending on things such as the market index used and the time period measured. Generally beta is used in CAPM of security valuation.

3)

Important concepts for individual investors while evaluating risk and return of investment: Following some parameters that should be considered by the individual investor while evaluating risk and return of investment.

· The Future plan of the issuing company.

· Operating efficiency and profitability of the firm.

· Economic policies like Fiscal and Monetary policy

· Political stability and international effect

· Regulations associated with the company.