ACFI201 - 3
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The principal revenue producing activities of the entity and other activities that are not investing or financing
The acquistion and/or disposal of long term assets and other investments not included in cash equivalents
Cash Flows relating to changes in the size and/or composition of the financial structure of the entity including equity and borrowings.
Formula: After Tax Cash Flows
Formula: Cash Collections from Customers
Sales + Op acc receivable - close acc reivable - bad debts - provision for DD - discount allowed
Formula: Cash paid to suppliers
COGS +closing inventory-opening inventory + opening acc payable - closing acc payable
Formula: Cash paid for other operating expenses
=Other operating expenses - non cash expenses - opening prepaid expenses + closed prepaid expenses +opening accrued expenses - closing accrued expenses
Formula: Cash paid for interest
= Interest expense + op accrued interest - close accrued interest
Formula: Cash paid for Tax
= Tax expense +op tax payable - close tax payable +op deferred tax - close deferred tax
- The return earned on investments represents the marginal benefit of investing.
- Risk represents the marginal cost of investing
Definition: Nominal Returns
Actual rate paid or earner before deducting the effects of inflation
Definition: Real Returns
The nominal rate adjusted for the effect of inflation
Definition: Effective Return
The nominal rate adjusted for the effect of the rate paid or earned being calculated more frequently than once per annum (adjusted to represent effects of compounding)
Definition: Expected Returns
The return that an investor expects to earn or receive on an asset given its price, growth, potential etc
Definition: Required Return
The return that an investor requires on an asset given its risk
Definition: Historical Returns
The return that an investor earned on an asset for a holding period
Definition: Equity Risk Premium
- The difference in equity returns and returns on safe investments.
- Implies stocks are riskier than bonds or bills
- Trade off always arises between risk and expected return
The total gain or loss experienced on an investment over a given time period
Formula: Return on a Single Asset
Formula: Arithmetic Average Return
Difference between Geometric and Arithmetic Mean
- Arithmetic mean usually overstates the mean.
- The difference between the 2 is greater as volatility increases.
- They would be the same if there was no change in the returns
Definition: Investment Risk
Occurs because of the probability of earning a return less than that expected The greater the chance of a return below expected, the greater the risk
Standard Deviation measures...
the dispersion or variability around the expected value
Formula: Coefficient of Variation
Coefficient of Variation
- A measure of the relative dispersion of a probability distribution
- Measures the risk per unit return.
- Use: Using standard deviation to compare the riskiness of two projects can be misleading when the projects are of unequal sizes.
- A relative measure of risk
Investors are either Risk neutral, Risk Seeking or Risk Averse. Historical returns on financial assets are consistent with a population of risk averse investors
- If two assets have equal expected returns, the the one with lower risk dominates.
- if two assets are equally risky, then the one with higher returns dominates
- Can also be non-dominated
Formula: Expected Return for a Portfolio
Importance of Covariance
- Risk reduciton is achieved in portfolios because fluctuations in one asset are partially offset by fluctuations in another asset.
- Risk of a portfolio depends crucially on whether the returns on the portfolio's components move together or in opposite directions.
Formula: Variance on a Two Asset Protfolio
Correlation Coefficient and Risk Reduction
- A two stock riskless portfolio can be formed if (rho) = -1
- Risk is not at all reduced if (rho) = +1
- Generall stocks have (rho) about .35
Risk related to market movements(eg interest rates)
- Variability of returns unique to the company.
- In a large market a protfolio of 20 randomly selected stocks eliminates most unsystematic risk
- A meausre of volatility of a security's returns relative to the broad-based market returns.
- Beta for entire market = 1 since the correlation of market portfolio returns with itself is one.
- Through diversifying, investors can eliminate unique risk, so only systematic risk is priced.
- The market compensates investors for accepting risk, but only for systematic risk
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