Understanding Risk and Return in Single Stock Investments
Learning Objectives
After completing this lecture, you will understand the following topics:
- Introduction to Risk
- Risk and Return for Single Stock Investments
Before discussing this important topic, let’s review the areas of finance we have studied so far.
Part I: Introduction and Capital Budgeting
- Financial Markets, Concepts, Definitions
- Review of Accounting
- Interest Rate Theory and Calculations
- Investment Decisions: Net Present Value (NPV) (Valuation), Internal Rate of Return (IRR), Payback
- Capital Budgeting:
Key Financial Ratios and Their Significance
Net Capital Ratios (Expressed in Days)
- Days Receivable = (Accounts Receivable / Sales) x 365
- Days Inventory = (Inventory / Cost of Goods Sold) x 365
- Indicates how many days a product takes to be totally sold.
- Days Payable = (Accounts Payable / Purchases) x 365
- Indicates the average time (in days) that a company takes to pay its bills and invoices to its trade creditors.
- A high (low) DP indicates that a company is paying its suppliers slower (faster).
- Operating Cycle = Days Inventory + Days Receivable
- Average
Fixed Income Derivatives: Forwards, Futures, and Swaps
Introduction to Fixed Income Derivatives
1. Introduction
A derivative is a security whose value depends on the value of another security. Hedgers include oil producers, farmers, and other commodity producers.
2. Over-the-Counter Markets (OTC)
A decentralized market where dealers are connected through telephone, the internet, and proprietary electronic trading systems (for forwards and swaps).
- Advantages: Terms of contracts are privately negotiated.
- Disadvantages: Counterparty risk.
3. Exchange-Traded Markets
A
Read MoreInvestment Decisions: NPV, IRR, and Discounted Cash Flow
Chapter 8: NPV and Other Investment Criteria
NPV = PV – Initial Investment
A positive NPV means that the project is expected to add value to the firm and, therefore, will increase the wealth of the owner. Accept a project if NPV > 0.
IRR: The project’s expected return. If the cost of capital (required return) equals the IRR (expected return), the NPV = 0. A project’s IRR is the discount rate that makes its NPV = 0. Accept the project if the IRR is greater than r (the project’s cost of capital).
Read MoreStock Returns, Risk, and Portfolio Management
Stock Returns and Risk Premium
1. Calculating Percentage Return on a Stock
What is the percentage return on a stock that was purchased for $50.00, paid a $3.00 dividend after one year, and was then sold for $49.00?
Formula: % Return = (Capital Gain + Dividend) / Initial Share Price
= ($49.00 – $50.00) + $3.00 / $50.00
= 4.00%
2. Calculating Inflation Rate
If a share of stock provided a 14.0% nominal rate of return over the previous year while the real rate of return was 6.0%, then the inflation rate was:
Read MoreEurocurrency, Forex, EMS, Derivatives, and Options
Eurocurrency and the Eurodollar
A Eurocurrency is a claim (e.g., time deposit) in that currency held by a nonresident of the currency’s country of origin. Since the Eurodollar is the major Eurocurrency, it is a U.S. dollar claim arising from a dollar‑denominated deposit, note, or bond held by a nonresident of the United States.
The LIBOR (London Interbank Offer Rate) fixing is the base rate in the Eurocurrency market. (Offer Rate = Ask Rate) It represents the average rate at which leading multinational
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