2. Quantitative Methods Flashcards
What is the maturity premium?
A premium for the increased sensitivity of the price of a financial instrument with a longer time to maturity to changes in market interest rates.
What is an interest rate?
An interest rate is the rate of return that levels cash flows occurring on different dates and can be perceived as the price of money.
How is an interest rate viewed as a required rate of return?
It represents the minimum return that investors expect for providing their capital.
What does an interest rate signify as a discount rate?
It is used to determine the present value of future cash flows by discounting them back to their present value.
How does an interest rate function as an opportunity cost?
It represents the potential benefit lost by choosing one alternative over another, highlighting the cost of forgone opportunities.
Why is an interest rate considered the price of money?
Because it reflects the cost of borrowing money or the return on investment for lending money.
What is the real risk-free interest rate?
The interest rate for postponing consumption, not adjusted for inflation, with no default risk or liquidity constraints.
What forms the nominal risk-free interest rate?
The sum of the real risk-free interest rate and the inflation premium.
What is the default risk premium?
A premium for the possibility that the entity may fail to meet its financial obligations.
Why is a liquidity premium added?
To compensate for reduced or no liquidity, making it harder to sell the financial instrument.
What is the time value of money (TVM)?
TVM shows the relationship between time, present value (PV), future value (FV), and interest rate
How can an interest rate be perceived?
As a required rate of return, a discount rate, or an opportunity cost.
What questions do interest rates help answer?
Expected future profits from an investment, present value of a future amount, and future profits forgone in favor of current consumption.
What components make up the interest rate?
Real risk-free interest rate, inflation premium, default risk premium, liquidity premium, and maturity premium.
