Study & Review Guide
Exam 2:
Chapters 4 and 5
BUS 307 – 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 (and be able to
explain that briefly).
- 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.
- Make
sure you can 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.
- I will
not be asking for a calculation of portfolio expected return or standard
deviation. Neither will I be asking
for a calculation on portfolio beta (Formula 5.7).
- I will
not be asking for you to calculate beta or draw either a characteristic line
or security market line.
- I may
be asking for your interpretation of correlation, and definitely will be
asking for your interpretation of beta, and several calculations involving
beta:
- “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?
- More
exact return estimation, using the Capital Asset Pricing Model (Formula
5.8).
- 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?
- There
will be bonus opportunities as noted in class.