Ch 17

Question 1

Economic Investment

Answer 1

Either paying for new additions to the capital stock or new replacements for capital stock that has worn out

Question 2

Financial Investment

Answer 2

Refers to either buying an asset or building an asset in the expectation of financial gain

Question 3

Present Value

Answer 3

the present day value, or worth, of returns, or costs that are expected to arrive in the future

Question 4

Compound Interest

Answer 4

describes how quickly an investment increases in value when interest is paid, or compounded, not only on the original amount invested buy also on all interest payments that have been previously paid

Question 5

Stocks

Answer 5

ownership shares in a corporation

Question 6

Limited Liability Rule

Answer 6

limits the risks involved in investing in corporations and encourage investors to invest in stocks by capping their potential losses at the amount they paid for their shares

Question 7

Capital Gains

Answer 7

Selling shares in the corporation for more money than they paid

Question 8

Dividends

Answer 8

equal shares of the corporations profits

Question 9

Bankrupt

Answer 9

they are unable to make timely payments on their debts

Question 10

Bonds

Answer 10

Debt contracts that are issued most frequently governments and corporations

Question 11

Default

Answer 11

Fail to make the bonds promised payments

Question 12

Mutual Funds

Answer 12

A company that maintains professionally managed collects of either stocks or bonds

Question 13

Portfolio

Answer 13

a collection of stocks or bonds

Question 14

Actively Managed Funds

Answer 14

Have portfolio managers who constantly buy and sell assets in attempt to generate high returns

Question 15

Index Funds

Answer 15

portfolios are selected to exactly match a stock or bond index

Question 16

Passively Managed Funds

Answer 16

Index funds, chosen exactly to match whatever stocks or bonds are contained in their respective underlying indexes

Question 17

Percentage Rate of Return

Answer 17

percentage gain or loss over a given period of time

Question 18

Arbitrage

Answer 18

the name financial economists give to the buying and selling process that leads profit-seeking investors to equalize the average expected rate of return generated by identical or nearly identical assets

Question 19

Risk

Answer 19

The fact that investors never know with total certainty what those future payments turn out to be

Question 20

Diversification

Answer 20

Strategy of investing in a large number of investments to reduce the overall risk of the entire portfolio

Question 21

Diversifiable Risk

Answer 21

the risk that is specific to a given investment and that can be eliminated by diversification

Question 22

Nondiversifiable Risk

Answer 22

pushes all investments in the same direction at the same time so that there is no possibility of using good effects to offset bad effects

Question 23

Average Expected Rate of Return

Answer 23

the probability-weighted average of the investment’s possible future rates of return

Question 24

Probability-Weighted Average

Answer 24

each of the possible future rates or return is multiplied by its probability expressed as a decimal

Question 25

Beta

Answer 25

relative measure of nondiversifiable risk

Question 26

Market Portfolio

Answer 26

a portfolio that contains every asset available in the financial markets

Question 27

Time Preference

Answer 27

people tend to be impatient, they typically prefer to consume things in the present rather than in the future

Question 28

Risk-Free Interest Rate

Answer 28

Clearly indicate that the rate of return that they generate is not in any way compensation for risk

Question 29

Risk Premium

Answer 29

Avg Expected Rate of Return = i^f + risk premium (Risk free interest rate)

Question 30

Security Market Line (SML)

Answer 30

indicates how this compensation is determined for all assets no matter what their respective risk levels are

Question 31

Future Value

Answer 31

X Dollars Today = (1-i)^t Xdollars in t years

Question 32

Present Value

Answer 32

X/(1+i)^t dollars today = X dollars in t years