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Financial Concepts - Essay Example

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Financial Concepts

n to compensate for the underlying risk involved .This rate of return (Ke) is defined as the sum of risk free rate of return (Rf) and risk premium (Rm- Rf) multiplied by beta (KPMG, 2005).Thus beta is useful in calculating the rate of return of a risky asset and thus very applicable in investment decisions.
2.2. Variance- It is a standard statistical measure of the dispersion of a set of data points around their mean value. In finance, the variance of the market return is the expected squared deviation from the expected return (Myers, 2000). Variance is useful in measuring portfolio risk in the sense that it measures the volatility from average value. This helps the investors in risk assessment while purchasing stocks or bonds (Investopedia, 2010).
2.3. Duration: It is defined as the average number of years to an asset’s discounted cash flows (Myers,2000).It denotes how much sensitive is the price of a fixed income investment to a change in interest rates. The bigger the duration, the greater the reward for bond prices. Thus this is applicable in investment decisions.
2.4. Return on Assets (ROA): It is defined as the ratio of net income to total assets (Myers, 2000). It indicates how efficiently a company is using its total assets to generate its earnings. It is an indicator of a company’s efficiency and profitability.
2.5: Return on Equity (ROE): It is defined as the ratio of net income to shareholder’s equity(Myers,2000). It an indicator of the profitability of a company. It shows how profitable a company is making use of the money invested by the shareholders
2.6. Cost of Capital- Each firm expects a minimum rate of return on its investments as earnings for attracting new capital and to maintain its current value. This rate of return is called cost of capital (KPMG, 2005). The opportunity cost of investment in funds is reflected in cost of capital and hence it is a very important parameter for any company (Civil Aviation Authority, 2001). The two ...Show more


Beta-Beta is a measure of market risk and denotes the volatility or systematic risk of a portfolio or security when compared to the whole market (Myers, 2000). One of the most popular theoretical frameworks to measure the cost of capital is based on the Capital Asset…
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