Practice Question 30: The Risk Per Unit Of Return Is 019736

Practice Question 30the Risk Per Unit Of Return Is Measured By Therem

Practice Question 30the Risk Per Unit Of Return Is Measured By Therem

Practice Question 30 The risk per unit of return is measured by the [removed] Median. [removed] Standard deviation. [removed] Coefficient of variation. [removed] Variance. Practice Question 38 The expected return on Bevo stock is 12.6 percent. If the expected return on the market is 10 percent and the beta for Bevo is 1.4, then what is the risk-free rate? [removed] 2.0% [removed] 2.5% [removed] 3.5% [removed] 3.0% Multiple Choice Question 49 Julio purchased a stock one year ago for $27. The stock is now worth $32, and the total return to Julio for owning the stock was 37 percent. What is the dollar amount of dividends that he received for owning the stock during the year? [removed] $6 [removed] $7 [removed] $4 $5 Multiple Choice Question 87 The risk-free rate of return is currently 3 percent, whereas the market risk premium is 6 percent. If the beta of Lenz, Inc., stock is 1.8, then what is the expected return on Lenz? [removed] 8.40% [removed] 13.80% [removed] 19.20% [removed] 10.80%

Paper For Above instruction

The assignment involves analyzing key concepts in financial risk measurement and return calculation, focusing on the measurement of risk per unit of return, calculating the risk-free rate using the Capital Asset Pricing Model (CAPM), determining dividend amounts based on total returns, and estimating expected stock returns using given market data. This comprehensive review synthesizes these concepts to demonstrate their interconnectedness within financial decision-making and investment analysis.

Introduction

Understanding risk and return is fundamental to investment decision-making. Investors seek to maximize returns while minimizing risk, and the ability to accurately measure risk per unit of return, estimate expected returns, and calculate the dividend income are essential skills. This paper explores the key concepts surrounding these issues, primarily focusing on risk measurement, CAPM-based return estimation, and dividend calculation, providing a cohesive overview of their applications in finance.

Measuring Risk per Unit of Return

The risk per unit of return, often termed as the coefficient of variation (CV), is a crucial measure used to compare the relative risk associated with different investments. The CV is calculated by dividing the standard deviation of returns by the mean return, providing a normalized measure that allows investors to assess risk in relation to expected return. Unlike measures such as variance which quantifies absolute risk, the CV adjusts for the scale of the investment, thus enabling more meaningful comparisons across assets with different return levels (Bodie, Kane, & Marcus, 2014). This measure assists investors in selecting investments that optimize risk-reward trade-offs.

Estimating the Risk-Free Rate Using CAPM

The Capital Asset Pricing Model (CAPM) establishes a relationship between expected return on a security, risk-free rate, beta, and market return. The CAPM formula is:

Expected Return = Risk-Free Rate + Beta × Market Risk Premium

Given the expected return on Bevo stock (12.6%), its beta (1.4), and the expected market return (10%), the risk-free rate can be derived as follows:

12.6% = Risk-Free Rate + 1.4 × 6% (since the market risk premium is the difference between market return and risk-free rate)

Rearranging the formula, and recognizing that Market Risk Premium = Market Return - Risk-Free Rate, we solve for the risk-free rate:

12.6% = Risk-Free Rate + 1.4 × (Market Return - Risk-Free Rate)

12.6% = Risk-Free Rate + 1.4 × (10% - Risk-Free Rate)

12.6% = Risk-Free Rate + 14% - 1.4 × Risk-Free Rate

12.6% - 14% = Risk-Free Rate - 1.4 × Risk-Free Rate

-1.4% = (1 - 1.4) × Risk-Free Rate

-1.4% = -0.4 × Risk-Free Rate

Risk-Free Rate = -1.4% / -0.4 = 3.5%

Thus, the risk-free rate associated with Bevo stock is approximately 3.5%, aligning with the multiple choice options.

The Dollar Amount of Dividends Received

Julio's total return includes both capital gains and dividends. The total return can be expressed as:

Total Return = ( Ending Price - Beginning Price + Dividends ) / Beginning Price

Rearranged to find dividends:

Dividends = (Total Return × Beginning Price) - (Ending Price - Beginning Price)

Dividends = (0.37 × $27) - ($32 - $27) = $9.99 - $5 = $4.99

Rounding to the nearest dollar, Julio received approximately $5 in dividends during the year.

Expected Return Using CAPM

The expected return on Lenz, Inc., stock can be computed using the CAPM formula:

Expected Return = Risk-Free Rate + Beta × Market Risk Premium

Expected Return = 3% + 1.8 × 6% = 3% + 10.8% = 13.8%

This expected return aligns with the multiple choice option of 13.80%, illustrating the importance of beta as a measure of systematic risk and the market risk premium.

Conclusion

Assessing risk and return remains central in financial analysis. The coefficient of variation provides a meaningful measure of risk per unit of return, aiding in investment comparisons. The CAPM framework enables estimation of necessary rates like the risk-free rate and expected returns based on systematic risk measures such as beta. Additionally, accurate dividend calculations help investors understand income components of total returns. These interconnected concepts support more informed and strategic investment decisions, ultimately fostering better risk management and return optimization in financial markets.

References

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• Fama, E. F., & French, K. R. (2004). The Capital Asset Pricing Model: Theory and Evidence. Journal of Economic Perspectives, 18(3), 25-46.
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