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Risk Management in Investments

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Risk management relates to reducing the cost of risk, meaning reducing the cost of the actual management of risk. People invest their money, whether it's in bonds or stocks, with the hope of acquiring profit or gains. The question one shall ask regarding risk management, is the risk appropriate given the returns?

a) Therefore, please select a Fortune 500 Company that is facing challenges similar those stated above (risk management in terms of a company's investments), and describe a series of optimal financial strategies for that company. This description should include an evaluation of the company's financial performance and a discussion of financial strategies.

b) Consider whether a merger or acquisition could positively impact your chosen Fortune 500 Company's strategic outlook. Describe the pros and cons for such a venture, including possible synergies, cost savings, and moral issues.

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a) Let's think about Hewlett Packard (HP). The company is world's largest computer and electronics company, ranking 11th in the Fortune 500 list and has a powerful team of 142,000 employees doing business in more then 170 countries. The company had has headquarters in countries like Canada, Singapore, Japan and Switzerland and it's Research and Development (R&D) investment of nearly $4 billion continuously fuels the invention of new products, solutions and technologies. HP's quick ratio has made a great increase in the last three years which is a sign of increasing liquidity improvement for the creditworthiness of the company.

As the competition increases, the firm needs to establish investment strategies that can provide adequate funds for the new projects to compete with other rivals like Dell, Toshiba etc... Stocks can offer greater returns in the short term but they ...

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Risk Management in Investments is studied.

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Investment Fundamentals and Portfolio Management: return on stock, holding-period return on investment, margin account, market price per share, value of stock, expected return of the portfolio, beta of the portfolio, CAPM, value of options at expiration

Whopie, market to book value ratio, earnings multiple, Elvis Alive Corporation,

1. John Smith has been reviewing the stock of ABC. John has estimated that the stock will have the following possible returns and probabilities:

Return Probability

-0.15 0.10
-0.05 0.20
0.05 0.35
0.15 0.25
0.25 0.10

a. Compute the expected return on ABC stock.
b. Compute the standard deviation of returns on ABC.

2. A stock sells for $67 per share and pays a quarterly dividend of $0.50. One year later, the stock sells for $76.

a. Compute the holding-period return on this investment.
b. Compute the holding period return assuming that the investor could buy this stock borrowing half of the purchase price at 12 percent per annum interest.
c. Compute the holding period return (including the information from part b) if the investor pays a commission of $0.40 per share on both the purchase and sale transaction.

3. You open a margin account with a brokerage firm. The initial margin requirement is 50 percent, and the maintenance margin requirement is 25 percent. You purchase 100 shares of a stock selling for $40 per share.

a. How much money do you need to have in your margin account to make this purchase? (Ignore commissions.)
b. What is the amount of your margin loan from the broker?
c. If the stock falls to $32, what is the margin in the account?
d. At what stock price will you receive a margin call?

4. What is the market price per share of Whopie, Inc. if the firm had net income of $200,000, earnings per share of $2.70, total equity of $800,000, and a market to book value ratio of 1.5?

5. The companies in the electrical parts industry have an average earnings multiple of 16. John's Parts, Inc. manufactures electrical parts, and you have forecast that the company will earn $3.60 per share and its stock will sell at the industry average multiple 3 years from now. Estimate the value of John's Parts stock in 3 years. If the required rate of return is 14 percent, what is the present value of John's Parts stock?

6. Tom Jones has identified the following securities for a portfolio:

Security Amount Invested Expected Return Beta

A $25,000 0.05 1.4
B $35,000 0.11 0.1
C $5,000 0.15 0.5
D $35,000 0.01 1.9

Compute the expected return of the portfolio. Compute the beta of the portfolio.

7. The Elvis Alive Corporation, makers of Elvis memorabilia, has a beta of 2.35. The return on the market portfolio is 13%, and the risk-free rate is 7%. According to CAPM, what is the risk premium on a stock with a beta of 1.0?

8. Discuss the 3 forms of market efficiency and the evidence for each form of market efficiency.

9. Compute the value of the following options at expiration:

a. An IBM July 90 call when IBM sells for $98
b. An Eastman Kodak April 25 call with the stock priced at $19
c. A Wall-Mart January 60 put with Wal-Mart stock selling for $48
d. A Pfizer October 35 put with the stock priced at $42.

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