# Basic Measures, Policy Statement, and Securities Markets

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Basic Measures, Policy Statement, and Securities Markets

Alvaro Reis Professor Dr. Anthony Criniti. October 16, 2011

Corporate Investment Analysis

Abstract

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Investment world has become in a very competitive arena where every penny if battled. Financial analyst need different tools to scrutinize the market and identify the most succulent securities available for their clients, to accomplish this objective they utilize different mathematical and statistical calculations like arithmetic mean, geometric mean and standard deviation, this paper shows how to perform these calculations and how they could be used to identify a good investment. Additionally, provides an overview in formulating and justifying investment policies identifying objectives and constraint considerations. Finally, market transactions area analyzed to explain how limit transactions work in different scenarios as well as how high or low transaction volume will impact on the efficiency of markets.

Corporate Investment Analysis

1. During the past five years, you owned two stocks that had the following annual rates of return: Year Stock T Stock B 1 0.19 0.08 2 0.08 0.03 3 -0.12 -0.09 4 -0.03 0.02 5 0.15 0.04

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a. Compute the arithmetic mean annual rate of return for each stock. Which stock is most desirable by this measure? Arithmetic Mean: a mathematical representation of the typical value of a series of numbers, computed as the sum of all the numbers in the series divided by the count of all numbers in the series. Stock T: 0.19 + 0.08 + (-0.12) + (-0.03) + 0.15 = 0.054 = 5.40 % Stock B: 0.08 + 0.03 + (-0.09) + 0.02 + 0.04 = 0.16 = 1.60 % Based on the fact that Arithmetic Mean for stock T is greater than for stock B, stock T is more desirable. b. Compute the standard deviation of the annual rate of return for each stock. (Use Chapter 1 Appendix if necessary.) By this measure, which is the preferable stock? Stock T Years Rᵢ 1 0.19 2 0.08 3 -0.12 4 -0.03 5 0.15 Arithmetic Mean 0.054 Rᵢ0.136 0.026 -0.174 -0.084 0.096 (Rᵢ- )² 0.0185 0.0007 0.0303 0.0071 0.0092 Σ=0.0657

δ²/n = Σ(Rᵢ-R )² / Number of years = 0.0657 / 5 = 0.013144 δ/Variance = √ δ²/n = √ 0.013144 = 0.114647 = 11.4647 % Stock T Years 1 2 3 4 5 Arithmetic Mean Rᵢ 0.08 0.03 -0.09 0.02 0.04 0.016 Rᵢ0.064 0.014 -0.106 0.004 0.024 (Rᵢ- )² 0.0041 0.0002 0.0112 0.0000 0.0006 Σ=0.0161

δ²/n = Σ(Rᵢ-R )² / Number of years = 0.0161 / 5 = 0.003224 δ/Variance = √ δ²/n = √ 0.003224 = 0.056780 = 5.6780 % According to Investopedia.com standard deviation is a statistical measurement that sheds light on historical volatility. A volatile stock will have a high standard deviation while the deviation of a stable blue chip stock will be lower. Stock B is preferable because return on the fund is deviating less from the expected normal returns.

Corporate Investment Analysis

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c. Compute the coefficient of variation for each stock. (Use the Chapter 1 Appendix if necessary.) By this relative measure of risk, which stock is preferable? Coefficient of Variation (CV): a statistical measure of the dispersion of data points in a data series around the mean. It is calculated as follows: Coefficient of Variation = Standard Deviation / Expected Return Stock T: CV = 0.1146 / 0.054 = 2.12 Stock B: CV = 0.0567 / 0.016 = 3.55 According to wikipedia.org in the investing world, the coefficient of variation allows you to determine how much risk you are assuming in comparison to the amount of return you can expect from your investment. In simple language, the lower the ratio of standard deviation to mean return, the better your risk-return tradeoff. Base on the coefficient of variation stock T is preferable over stock b. d. Compute the geometric mean rate of return for each stock. Discuss the difference between the arithmetic mean return and the geometric mean return for each stock. Discuss the differences in the mean returns relative to the standard deviation of the...

References: Berk, J., & DeMarzo, P. (2010). Corporate Finance: The Core. New Jersey: Pearson Education, Inc. Investopedia. (2011, October). Retrieved October 2011, from Investopedia: www.investopedia.com Reilly, F., & Brown, K. (2009). Investment Analysis and Portfolio Management. Mason, Ohio: Cengage Learning. Wikipedia. (2011, October). Retrieved October 2011, from Wikipedia: www.wikipedia.org

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