Fundamentals of Finance - Desklib

This article covers the fundamentals of finance including investment risks, diversification, and evaluation methods. It provides answers to questions related to risk, coefficient of variation, and portfolio return. The article also includes a reference and bibliography section.

Running head: FUNDAMENTALS OF FINANCE
Fundamentals of Finance
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Author’s Note:

1FUNDAMENTALS OF FINANCE
Table of Contents
Answer to Question 1:.....................................................................................................................3
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Answer to Question 2:.....................................................................................................................3
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Answer to Question 3:.....................................................................................................................4
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Answer to Question 4:.....................................................................................................................5
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Answer to Question 5:.....................................................................................................................5
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Answer to Question 6:.....................................................................................................................6
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Answer to Question 7:.....................................................................................................................7

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Proficient Level:..........................................................................................................................7
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Reference & Bibliography:..............................................................................................................8

3FUNDAMENTALS OF FINANCE
Answer to Question 1:
Proficient Level:
According to Cornett, Adair & Nofsinger, 2016, risk of any investment is the volatility
level of the investment and it contains both the market specific factors and firm specific factor.
Generally, the risk level of any investment can be measured by computing the standard
deviation of the historical returns for a specific period.
Distinguished Level:
It has been observed from the investment market that for the last few decades the stocks
have highest standard deviation amongst the three investment options. On the other hand, the
lowest standard deviation is of T-bills. Hence, it can be stated that the stocks are the most risky
investment options and T-bills are the least risky options, whereas, bonds belong to the
moderately risky options.
Answer to Question 2:
Proficient Level:
The firm-specific risks are mainly associated with the factors related to the individual
firm or the industry, in which the firm belongs to. The sources of such risks are listed below:
- Market demand
- Management decisions
- High competition
- Change in the industrial structure
- Fluctuation of exchange rates

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Market risks are originated due to various macro-economic factors, which are as follows:
- Variation in interest rate
- Inflation
- Change in the preferences of investors
- Revision of Government policies
- Introduction of new taxation rules
Distinguished Level:
It has been noticed that all forms of investments, especially, risky investments, like
stocks, always bear some market risks. Hence, it cannot be diversified by any particular method.
However, the investors can diversify the firm-specific risks by investing in diversified
portfolios (Gotze et al., 2016).
Answer to Question 3:
Proficient Level:
Coefficient of variation is computed by dividing the standard deviation by the mean of a
series of data. In other words, it is the ratio of risk and return of any investment and helps to
measure the risk level of any investment, which has to be borne by investors to earn 1% return
from the particular investment.
Distinguished Level:
Lower coefficient of variation of any investment indicates that the investors have to bear
lower risk to earn 1% return from that investment in comparison to others. Hence, it is more
preferable for the investors.

5FUNDAMENTALS OF FINANCE
Answer to Question 4:
Proficient Level:
Particulars Nos. of Shares
Amount
per Share Total
a b c=axb
Closing Stock Price in Last year A 100 $107.69 $10,769
Dividend Paid in Last Year B 100 $0.35 $35
Closing Stock Price in Previous year C 100 $103.39 $10,339
Dollar Return D=(A+B)-C $465
Percent Return E=D/C 4.50%
Distinguished Level:
Dollar return is computed on the basis of the numbers and price of the share, whereas,
percentage return describes the return, earned for each share and each dollar. If the volume and
price of a specific stock is higher than other stock then the dollar return of the first stock may
become higher than the latter. However, the first stock may provide lower return for per stock
and per dollar. For this reason, the evaluation process by using percentage return is more easy
and effective than dollar return (Damodaran, 2016).
Answer to Question 5:
Proficient Level:
Stock Name
Standard
Deviation Rank
Able Co. 34% 1
Baker Co. 26% 2
Catco Co. 19% 3

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Distinguished Level:
The standard deviation formula contains the following components:
- Total number of observations (n)
- Values of individual observations (xi)
- Average value of total observations ( x)
The formula of standard deviation by using the mentioned components is as follows:
σ =∑
i=1
n
¿ ¿ ¿
Answer to Question 6:
Proficient Level:
Stock Name Return Risk
Coefficient
of Variation Rank
A B C=B/A
Baker Co. 13% 26% 2.00 1
Able Co. 15% 34% 2.27 3
Catco Co. 9% 19% 2.11 2
Distinguished Level:
Co-efficient of variation can be used to compute the volatility level of any investment,
which has to be borne for generating the return, expected by the investors. Thus, it acts as a
trade-off between the risk and return.

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Answer to Question 7:
Proficient Level:
Stock Name Return Weightage
Weighted
Return
A B C=AxB
Oracle 1.34% 10% 0.13%
Valero Energy 7.96% 45% 3.58%
McDonald's 0.88% 45% 0.40%
Portfolio Return 4.11%
Distinguished Level:
Weight of the individual assets in a portfolio helps to determine the actual return,
contributed by the asset in the total portfolio return, in accordance to its proportionate value
within the portfolio.

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Reference & Bibliography:
Baum, A. E., & Crosby, N. (2014). Property investment appraisal. John Wiley & Sons
Damodaran, A. (2016). Damodaran on valuation: security analysis for investment and corporate
finance (Vol. 324). John Wiley & Sons.
Gotze, U., Northcott, D., & Schuster, P. (2016). INVESTMENT APPRAISAL. SPRINGER-
VERLAG BERLIN AN.
McLachlan, C., Shore, L., & Weiniger, M. (2017). International investment arbitration:
substantive principles
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