Corporate Finance Assignment PDF

CORPORATE FINANCE
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CORPORATE FINANCE
PART 1
Question 1
With regards to any stock, two defining characteristics are risk and return. The risk inherent
in the share is on account of movement of the share price owing to which there is variation in
the share returns in different time periods (Damodaran, 2015). This is essentially represented
through standard deviation which highlights the extent of return values dispersion about the
average returns. Thus, if the dispersion of returns is high about the average returns, then it
would lead to higher standard deviation which would imply higher risk associated with the
underlying share (Brealey, Myers. & Allen, 2014).
The standard deviation concept is of high utility considering the stock returns are normally
distributed. This happen since in case of a normal distribution, the returns would be
distributed in a defined manner about the mean returns. This is represented by the empirical
rule in this regards which is diagrammatically captured as shown below (Arnold, 2015).
Taking the above distribution as reference, it is possible for the investors to estimate the
future average returns derived from the past performance of stock with reasonable accuracy.