Question

1) Please list the types of risks a firm may encounter. 2) Define BETA coefficient (in finance - CAPM) and explain what exactly it shows. 3) What is standard deviation, in general? What does it show? 4) How do I understand if Stock A is riskier than Stock B? 5) How do I understand if Bond A is riskier than Bond B? 6) What is “upside” and “downside” in finance? 7) If you need to match “Bondholders” and “Stockholders” with “upside” and “downside” how would you do this? (it does not have to be one-for-one) 8) Is market [systematic or undiversifiable] risk the same for all firms in the same market? 9) Are firm-specific [unsystematic or idiosyncratic] risks across the firms correlated? Briefly explain. 10) How could you relate the market interest rate changes with bond and stock prices?

Answer 1

1)

There are mainly two type of risks a firm may encounter.

a) Firm-Specific risk which are specific to the firm such as a risk of the labor strike, supplier risk, machine breakdown risk, bad debt risks etc.

b) Market risk which affects all the firms in the market such as new government regulations, the recession of economy etc.

2)

Beta is a measure of market risk of a stock compared to the market. It shows how much a particular stock will move in comparison to the market. Stocks with a beta less than 1 moves less than the market whereas stocks with beta higher than 1 moves more than the market. Stocks with more beta have more market risk associated with it.

3)

Standard deviation is the measure of variation. It measures the riskiness of an asset.

4)

Standard deviation is the measure of risks and higher the standard deviation means higher risks.

If stock A has higher standard deviation of returns then stock B, then the stock A is more risky than stock A.