University of Technology, Jamaica

FIN 4003: Securities Analysis

Academic Year 2021/22 - Semester 1
Tutorial 1: The Investment Settings & Risk

1) Go to the Jamaica Stock Exchange (JSE) Web site, www.jamstockex.com.

a. What is the mission of the JSE?
b. What are the Objectives of the JSE?
c. What are the Basic Functions of the Jamaica Stock Exchange?
2) Go to the Financial Services Commission (FSC) Website, www.fscjamaica.org.
a. What are the Ten Tips for Safe Investing?
b. What are the common Red Flags For Fraud?
c. What are the duties of the FSC mandated by the FSC Act?

3) Define investment. Discuss the common goals for investing.

4) Divide a person’s life from ages twenty to seventy into ten-year segments and
discuss the likely saving or borrowing patterns during each of these periods.

5) Distinguish between the following and give examples.

a) Securities and properties
b) Direct and indirect Investments.

6) Explain the three components of an asset’s required rate of return.

Required rate of return = Real Risk Free rate + Inflation Premium + Risk Premium.

7) What would be the required rate of return on an investment in an economy with a

3% real rate of return, expected inflation of 4%, and a risk premium of 4%? What
would you expect $1000 invested at this rate to grow to after ten years? After
twenty years?

8) Compute the required rate of return under the following scenarios:

a) Real rate =5%, expected inflation =6%, risk premium=2%
b) Real rate =3%, expected inflation =8%, risk premium=3%
 c) Real rate =4%, price index expected to change from 145 to 151, risk
premium =5%

9) Briefly explain the holding period return (HPR) and give several characteristics of
this measure.

10) On August 15, you purchased 100 shares of stock in the Cara Cotton Company at
$65 a share and a year later you sold if for $61 a share. During the year, you
received dividends of $3 a share. Compute your HPR and Return relative on
your investment in Cara Cotton.

11) Find the annualized returns for the following set of investments.
Asset HPR Holding period

A 10% 8 months B -6% 15 months

C 8% 2 years
D 15% 3 years
E 5% 18 weeks

12) Calculate and briefly describe the arithmetic versus geometric mean return for a
stock with five-year annual returns of -20%, 100%, 25%, 50%, -40%. Will the
arithmetic
return overstate the actual return earned by investors when there is substantial yearto-
year variation in returns?

13) Suppose you bought a stock for 15. The next year it jumped to 30, but you sold it
when it fell back to 15 in the following year. Compute the arithmetic and
geometric returns for your two-year holding period. Explain why your actual
investment return is measured by the geometric mean return and not by the
arithmetic average rate of return.
 14) Calculate and briefly characterize the coefficient of variation for the Lehman U.S.
Aggregate Bond Index for the 2003-07 period given annual returns of 4.10%
(2003), 4.34% (2004), 2.43% (2005), 4.33% (2006), and 6.97% (2007).

The arithmetic is the simple average return over the periods. In this case
arithmetic return is simple the sum of annual returns, all divide by 5

Arithemetic average= (4.10%+4.34%+2.43%+4.33%+6.97%)/5=4.42%

SD=(4.10%-4.43%)2 +(4.34%-4.43%)2+(2.34%-4.43%)2+(4.33%-4.43%)2+(4.33-
4.43%)2/4)1/2= 1.63%

CV= SD/Average return

=1.63%/4.435
=0.37%
Therefore, the cost of each percentage point of expected return is 0.37% in
standard deviation (or Risk). In 2003-07 the period was unusally calm for both
bond and stock market investors, but volatility with a vengeance in 2008.

15) Consider the following risk and return measures for four stocks:
Expected Return Standard Deviation

AAPL 15% 20%

GOOG 20% 30%

SIRI 25% 50%

V 12% 12%
a) Rank order these stocks from least risky to most risky using the coefficient of
variation.

Coefficient of variation
Standard deviation/ expected return

V= CV =12% / 12%=1
AAPL= CV=20% / 15%=1.33
GOOG= CV=30% / 20%=1.5
SIRI= CV= 50% / 25%=2

Among these investment alternatives V offers the lowest risk/reward ratio.

b) Now rank these stocks from most attractive to least attractive for risk-seeking
speculators focused only on absolute, not relative risk.

Standard deviation
SIRI 50%
GOOG 30%
AAPL 20%
V 12%
Among the investment alternative, SIRI offers the most absolute volatility and would
appeal to risk seeking speculators.

16) Your rate of return expectations for the common stock of Gray Disc Company during
the next year are as follows.

Possible
Rate of
Return Probability
-10% 0.25
0% 0.15
10% 0.35
25% 0.25

a) Compute the expected return, the variance and standard deviation of the asset.
Expected return= (0.25)(-10)+(0.15)(0)+(0.35)(10)+(0.25)(25)=7.25 or 0.0725

Variance= (0.25)(-0.10-0.0725)2 +(0.15)(0-0.0725)2+(0.35)(0.10-0.0725)2+(0.25)

(0.25-0.0725)2

= (0.25)(0.2976)+(0.15)(0.0053)+(0.35)(0.0008)+(0.25)(0.0315)= 0.0164

SD= (0.0164)1/2 =0.128

b) Under what conditions can the standard deviation be used to measure the relative
risk of two investments?
Standard deviation can be used as a good measure of relative risk between two
investments that have the same expected rate of return.

c) Under what conditions must the coefficient of variation be used to measure the
relative risk of two investments?
The coefficient of variation must be used to measure the relative variability of two
investment if there are major difference in the expected rates of return.