Study & Review Guide

Exam 2:  Chapters 4 and 5

Business Finance

 

 

 

Remember, we are focusing on calculations and their interpretation on this exam.  Make sure you know Ecclesiastes 11:2 (NIV) and which principle it supports.  Make sure you study the ethics boxes for this unit as well.

 

  1. 75%-80% of point value of this exam comes from Chapter 4.  Make sure you can do all the homework problems from both chapters efficiently, which means keep practicing them.  Be able to interpret the numbers you get.
  2. Make sure you can calculate and interpret the three single asset risk measures (range, standard deviation, coefficient of variation) in Chapter 5.  I may not have you calculate all of them, but I anticipate asking for your interpretation and comparisons of two or three assets’ risk measures.
  3. I will not be asking for a calculation of portfolio expected return or portfolio standard deviation (but will expect you to be able to calculate both of those for a single asset).  Neither will I be asking for a calculation on portfolio beta (Formula 5.7).
  4. I will not be asking for you to calculate beta or draw either a characteristic line or security market line.
  5. I may be asking for your interpretation of correlation, and definitely will be asking for your interpretation of beta, and several calculations involving beta:
    1. “Quick and dirty” return estimation, given a stock’s beta and the expected market return

                                                              i.      Estimated asset return = asset’s beta X estimated market return

                                                            ii.      Example:  TNM’s beta is 0.30 (is this high or low?  More or less risky, given that the market’s beta is 1.0?).  We find that a brokerage house estimates that the market return this year will be +5%.  What should be TNM’s return?
Solution:  +1.5% = 0.30 x +5%
Thought question:  then why would anyone want to buy TNM?

    1. More exact return estimation, using the Capital Asset Pricing Model (Formula 5.8).
    2. Example of correlation question:  I have one stock in my portfolio.  I wish to add a second stock, and I have two candidates:  one has returns with a +1 correlation with my existing investment, and the other has returns with a 0.45 correlation.  Which one should I add?
  1. There will be bonus opportunities as noted in class.