Chapter 3 Flashcards
Investment risk
- not necessarily in economic & financial terms
- but rather into volatility of the security itself & volatility of the market as a whole.
- the greater the risk assumed by investor, the higher his required rate of return.
Types of investment risk
- Systematic risk/market risk
- Unsystematic risk (firm-specific risk)
Systematic risk
- risk that cannot be reduced or eliminated through diversification
- arises from general economic conditions
- i.e. non-diversifiable risk
Unsystematic
- risk that can be eliminated through proper diversification
- risk unique to the firm eg. Labour strike, product failure
- i.e. diversifiable risk
Stock Beta formula
ri = rRF + (rM – rRF) βi
what is βi?
- beta coefficient of a stock
- or index of market risk
- basically just a measure of risk
- if higher than 1 means is risky, if lower than less risky
ri is?
required rate of return on a stock
rRF
- risk-free rate of return
- measured by the return on a treasury bill
rm
required rate of return on an average stock in the market
RPM formula?
rM - rRF
return required for any security formula
risk-free rate + the market risk premium X security’s beta.
βp
beta of portfolio
Terms ON BOND (=> debt)
- Coupon
- Maturity
- Face/par value
- Yield
Coupon
Coupon rate = Nominal yield = Interest income to holders of Bond/Loan Stock : fixed rate coupon (semi-annually OR annually)
Maturity
period before the bond can be redeemed, i.e. Issuer repay all capital to investor.
Face/par value
- represents original value of obligation & is usually $1,000.
- Market prices bonds rise above or fall below their principal values because of the differences between their coupon & prevailing market rate of interest.
Yield
rate of coupon as a percentage of bond current market price
yield to maturity on a bond is the…
discount rate that sets the present value of the bond’s future cash flows to its current market price.
