PART 2 SECTION-B corporate finance, risk and return





It includes six topics,

1.      Risk and return

2.      Long-term financial management

3.      Rising capital

4.      Working capital management

5.      Co-operate restricting and business combination

6.      International Finance


Ø  Risk and return:

The return that is investor receives usually comes in one or both two ways.

The value of the investment increases and the investor can sell it for a price high than they paid for it.

Example: return on that investment [ dividend or investment ] risk investment offers a higher return.


Returns are income received by an investing on investment. the annual rate of return is expressed as a percentage of the principal amount received.


The annual rate of return= return received on invested ÷ investment.



It is the possibility of having an unfavorable event occur. In investing, it is the risk that the value of an investment decreases. Risk can be classified as either a pure risk or a speculative risk.


Pure risk:

It is defined as the enhancement that an uncounted and harmful event will take place. Insurance is used to address risk because pure risk yields only a loss.


Speculative risk:

It is the type of risk involved in interest. is defined as the variability of actual return from expected return and this variability?

Example: may be either gain or loss.

Ø  Types of risk:

In general investment risk fall into 2 broad categories.

1.      Systematic risk

2.      Unsystematic risk.


Ø  Systematic risk: [market risk]

It is the risk that affects all investments. Some examples of systematic risk are inflation, political major issue, war, and civil unrest. Systematic risk cannot be diverted. Systematic risk includes foreign exchange risk.

Foreign exchange risk:

It is the risk that transactions denominated in foreign currencies will be impacted negatively by changes in the exchange rate.

Purchasing power risk:

It is the risk that the purchasing power of the fixed amount of money will decline as a result of inflation.

Market risk:

It is the risk inherent in an investment that is traded on a market simply because it is traded on a market and is subject to market movement.

Interest rate: [ price risk, maturity risk]

It is the risk that the value of an investment will change over time as a result of changes in the market rate of interest.

Market rate> company rate = discount

Market rate< company rate = premium


2. unsystematic risk company or nonmarket risk:

It is a risk that is specific to a particular company or to the industry in which the company operates.

Examples: employee strikes, machine brakes, etc.

Unsystematic risk can be reduced through appropriate diversification.

It includes,

Credit or default risk:

It is a risk that a borrower the money will not be able to pay interest and principal on debt as it becomes due.

Credit risk increases return increase.

Industrial risk:

It is a risk that is specific to companies in a particular industry.

Business risk:

It arises because of the variability of an individual firm's earnings before interest and tax.

Liquidity risk:[ marketability risk]

It is the possibility that an investment cannot be sold [ converted into cash] for its market value.


Political risk:

It is the risk that arises due to political issues.


Ø  The relationship between risk and return:

Investors are risk abuse, risk increases return increases.


CAPM[ capital asset pricing model]:

It helps to determine investors' required rate of return. The investors required rate of return is the minimum return investors will accept for an investment.


R = RF + beta [ RM – RF]



It measures the systematic risk of an investment. It measures how the securities return compares to the return of the market at the all.

 Beta= 1 :

When the market increases by 5% a security with a beta of 1 have also increased similarly market has decreased by 3% a security with a beta of 1 has also fallen by 3%.


A beta greater than 1:

It means that individual security has more volatile than the market. For example: if the market return has risen by 1%, the return on the stock has increased by more than 1%. These securities are called aggressive securities.

A beta less than 1:

Less volatile securities.


When the return to the market has risen by 1% the return to the stock has increased by less than 1%.these securities are called defensive security.

Beta= 0:
it is risk-free security.

Example: a beta = 0 means only that historically there has been no relationship between that security return and the return of the market.

Beta= negative [ less than zero]

It means that when the return to the market has increased the return to that security has decreased and wise versa.

Market risk premium:

Market risk premium = RM- RF

Stock risk premium:

Stock risk premium = beta (RM-RF)



You have to wait 45 seconds.

Generating video classes Link...

cmakid is a official cma usa free learning website this is a non profit business, so anyone can learn cma usa course for free in this site, this is a beginning of our service, we provide more content in future, therefore you can follow our website for commercial learning help

Post a Comment

Previous Post Next Post