B1 - M5: Financial Risk Part 1 Flashcards
What makes a financial instrument meet the criteria to be categorized as a “derivative”?
A derivative is a financial contract which DERIVES its value from the performance of another asset or financial contract. (e.g. Interest Rate Futures, Hedging Transactions)
What are the broad categories of risk?
“DUNS: D-iversifiable, U-nsystematic, N-on Diversifiable,
S-ystematic”
What is Diversifiable Risk?
Diversifiable Risk CAN be eliminated by the EFFECTIVE application of Portfolio Theory. This is also known as UNSYSTEMATIC RISK.
What is Non-Diversifiable Risk?
Non-Diversifiable Risk CANNOT be eliminated by the application of Portfolio Theory. This is also known as SYSTEMATIC / MARKET RISK.
What is Systematic (or Market) Risk?
Non-Diversifiable Risk CANNOT be eliminated by the application of Portfolio Theory. This is also known as SYSTEMATIC / MARKET RISK.
What is Un-Systematic Risk?
Diversifiable Risk CAN be eliminated by the EFFECTIVE application of Portfolio Theory. This is also known as UNSYSTEMATIC RISK.
What is a “Put Option”?
A Put Option allows you to “PUT a security ON THE MARKET” and sell it under specified terms of price and time.
What is a “Call Option”?
A Call Option allows you to “CALL a security OFF THE MARKET” and buy it under specified terms of price and time.
What are the risk implications of Short Term Financing?
Short Term Financing results in lower interest rates up front (lenders want to entice borrowers), but expose the borrower to potentially higher interest rates in the intermediate future. This results in a HIGHER degree of INTEREST RATE RISK.
What are the risk implications of Long Term Financing?
Long Term Financing results in a slighly less favorable rates compared to short term financing, but this is the cost of stability over the long haul. Long Term Financing results in less loan activity and less exposure to volatile interest rates which could hurt an organization’s ability to acquire new credit. Thus, Long Term Financing results in a LOWER degree of CREDIT RISK.
How is APR (annual percentage rate) calculated?
APR is equal to the amount of interest payments required under the contract DIVIDED BY the net proceeds of the debt.
What is the difference between “Real Dollars” and “Nominal Dollars”?
Real Dollars represent the expected value of a transaction. Nominal dollars is the representation of that actual value when the TIME and INFLATION have been applied to the expected Real Dollar amount.
