BPM: Financial Risk Management

Question 1

Risk Averse

Answer 1

Managers that anticipate greater return for greater risk

Question 2

Risk Indifferent

Answer 2

describes a manager who is neutral with regard to the return associated with a particular investment. Typically, the amount of a risk free rate of return associated with an investment of a given amount compared to a higher return associated with higher risk is viewed as having equal value.

Question 3

Risk seeking behavior

Answer 3

behavior describes managers who seek reduced return for higher risk

Question 4

Liquidity risk

Answer 4

desire to sell their security, but cannot do so in a timely manner or when material price concessions have to be made to do so.

Question 5

Interest rate risk

Answer 5

is the fluctuation in the value of a “financial asset” when interest rates change

Question 6

Purchasing power risk

Answer 6

risk that price levels will change and affect asset values (mostly real estate).

Question 7

Market Risk

Answer 7

The exposure of a security or firm to fluctuations in value as a result of operating within an economy is referred to as market risk.

Question 8

Credit Risk

Answer 8

Affects borrowers. If Risk increases then Interest rate will increase

Question 9

Default Risk

Answer 9

Affects lenders. may not repay the principal or interest due

Question 10

Stated Interest Rate (Definition)

Answer 10

represents the rate of interest charged before any adjustment for compounding or market factors. Shown in the agreement of indebtedness

Question 11

Computation Of Return

Answer 11

compensates investors and creditors for assumed risk

Question 12

Effective Interest Rate

Answer 12

Actual finance charge associated with a borrowing after reducing loan proceeds for charges and fees related to a loan origination

Question 13

Computation of Effective Interest Rates

Look at Page 40 for example

Answer 13

Effective Interest Rates are computed by dividing the amount of interest paid based on the loan agreement by the net proceeds received.

Question 14

Annual Percentage Rate (APR)

Look at Page 40 for example

Answer 14

Effective Periodic Rate X # of compounding periods

Question 15

Effective Annual Interest Rate

Answer 15

=[1+(i/p)]p-1

i= Stated interest rate
p = compounding periods per year

Question 16

Compound Interest

Answer 16

Interest paid only on the original amount of principal without regard to compounding

Question 17

Compound Interest Formula

Answer 17

FVn= P(1+i)n
P= Original Price
i= Interest rate
n= Number of periods

Question 18

Maturity Risk Premium

Answer 18

the compensation that investors demand for exposure to interest rate risk over time

Question 19

Purchasing Power Risk or Inflation Premium

Answer 19

compensation investors require to bear the risk that price levels will change and affect asset values or the purchasing power of invested dollars

Question 20

Liquidity Risk Premium

Answer 20

The additional compensation demanded by lenders

Question 21

Default Risk Premium

Answer 21

additional compensation demanded by lenders for bearing the risk that the issuer of the security will fail to pay interest and/or principal due on a timely basis

Question 22

Subjective Probability

Answer 22

based on an individuals belief about the likelihood that a given event will occur

Question 23

Expected Value

Answer 23

is the weighted- average of the probable outcomes