BPM: Financial Risk Management Flashcards
Risk Averse
Managers that anticipate greater return for greater risk
Risk Indifferent
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.
Risk seeking behavior
behavior describes managers who seek reduced return for higher risk
Liquidity risk
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.
Interest rate risk
is the fluctuation in the value of a “financial asset” when interest rates change
Purchasing power risk
risk that price levels will change and affect asset values (mostly real estate).
Market Risk
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.
Credit Risk
Affects borrowers. If Risk increases then Interest rate will increase
Default Risk
Affects lenders. may not repay the principal or interest due
Stated Interest Rate (Definition)
represents the rate of interest charged before any adjustment for compounding or market factors. Shown in the agreement of indebtedness
Computation Of Return
compensates investors and creditors for assumed risk
Effective Interest Rate
Actual finance charge associated with a borrowing after reducing loan proceeds for charges and fees related to a loan origination
Computation of Effective Interest Rates
Look at Page 40 for example
Effective Interest Rates are computed by dividing the amount of interest paid based on the loan agreement by the net proceeds received.
Annual Percentage Rate (APR)
Look at Page 40 for example
Effective Periodic Rate X # of compounding periods
Effective Annual Interest Rate
=[1+(i/p)]p-1
i= Stated interest rate p = compounding periods per year
Compound Interest
Interest paid only on the original amount of principal without regard to compounding
Compound Interest Formula
FVn= P(1+i)n P= Original Price i= Interest rate n= Number of periods
Maturity Risk Premium
the compensation that investors demand for exposure to interest rate risk over time
Purchasing Power Risk or Inflation Premium
compensation investors require to bear the risk that price levels will change and affect asset values or the purchasing power of invested dollars
Liquidity Risk Premium
The additional compensation demanded by lenders
Default Risk Premium
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
Subjective Probability
based on an individuals belief about the likelihood that a given event will occur
Expected Value
is the weighted- average of the probable outcomes
