Question

A.

For the last question, suppose you hear some information that leads you to believe that the stock is more risky than you first assumed.  You still think that your assumption about the value of the stock in three years is the best estimate, but you are concerned that the variance in that estimate is larger than you expected.  How might you adjust your calculations to account for the greater risk?

B.

You are considering two potential investments.  One is an established company with a history of consistent earnings growth, while the other is a new IPO with a short track record.  You think that the stock of both companies will be worth $100 in three years.  How would a risk-averse investor differ in his or her value calculations for each of the investments?

C.

1. What is the future value of $100 invested at 7% for five years?

D

1. The CAPM principles assume that most investors exhibit which of the following behaviors?
   1. Risk loving
   2. Risk neutrality
   3. Risk aversion

Answer 1

A

Instead of looking at absolute and nominal returns, one great way to look at risk would be from the perspective of risk-adjusted returns.

Those risk adjusted returns will incorporate the higher than anticipated risk and let us know if our returns were worth the higher than accounted for risk

B

A risk averse investor would not care about the stock price, rather care about the valuation of the stock. The stock with a reasonable valuation along with a high valuation growth perspective in the one that a risk averse investor will choose

C

FV = 100* (1 7%)^5 = 140.25

D

CAPM theory believes that most investors are risk averse

The CAPM assumes investors have homogeneous expectations, are rational and risk-averse and thus assign the same value to all assets to create the same risky market portfolio. If investors are heterogeneous, their different beliefs could result in a valuation or price for a security different from the CAPM-calculated price