Question

1. What’s the relationship between a bonds rating and its required rate of return?
   • What are the accept/reject rules for NPV and IRR?
   • What is the difference between beta, diversifiable risk and standard deviation?
   • What does the coefficient of variation tell us?

Answer 1

Higher is the bond rating lower is the risk and hence lower is the required rate of return. Lower is the bond rating higher is the risk and hence higher is the required rate of return.Bond Rating is inversely related to required rate of retrun.

For Independent rejects project with NPV greater than 0 should be selected .IRR should be greater than cost of capital should be accepted else rejected. For mutually exlusive projects higher NPV projects should be chosen. IRR should not be used for mutually exclusive projects.

Beta represents the correlation of stock returns and market returns. It represents the systematic risk which cannot be diversified away. Higher the beta higher is the systematic risk, lower the beta lower is the systematic risk.
Diversifiable risk are risk which affects a particular company or industry and can easily be minimized by increasing the number of stocks in portfolio or by using stocks with low correlation.
Standard deviation is the dispersion of returns over the mean return of a stock. It represents standard risk of a firm

Coeffiecient of Variation is standard Deviation/Expected Return. It is Risk to return ratio. Higher the risk to return of portfolio less attractive is the portfolio and lower is the coefficient if variation better is the portfolio .