Chapter 5

Question 1

Measures the total return expressed as a percent change from the initial investment

Answer 1

What is a Holding Period?

Question 2

Explicitly accounts for compound interest

Answer 2

What are Effective Annual Rates?

Question 3

What are the items below describing?

• Supply of funds from savers, primarily households
• Demand for funds from businesses to be used to finance investments in plant, equipment, and inventories
• Government’s net demand for funds as modified by actions of the Federal Reserve Bank
• Expected rate of inflation

Answer 3

Factors for Interest Rates

Question 4

The growth rate of your money

Answer 4

What is the Nominal Interest Rate?

Question 5

The growth rate of your purchasing power

Answer 5

What is the Real Interest Rate?

Question 6

Tax liabilities are based on (nominal/real) income and the tax rate determined by the investor’s tax bracket.

Answer 6

Nominal

Question 7

What are the items below describing?

• Predicts the nominal rate of interest should track the inflation rate, leaving the real rate somewhat stable.
• Appears to work far better when inflation is more predictable and investors can more accurately gauge the nominal interest rate they require to provide an acceptable real rate of return

Answer 7

The Fisher Equation

Question 8

What are the items below describing?

• Macroeconomic fluctuations
• Changing fortunes of various industries
• Firm specific unexpected developments

Answer 8

Sources of Investment Risk

Question 9

The return realized from a price change and any cash dividends collected

Answer 9

What is a Holding Period Return?

Question 10

The rate of interest that can be earned with certainty, commonly the rate on T-bills

Answer 10

What is a Risk-Free Rate?

Question 11

The difference between the expected HPR and the risk-free rate.

Answer 11

What is Risk Premium?

Question 12

The difference between actual rate of return and risk-free rate.

Answer 12

What is Excess Return?

Question 13

Dictates the degree to which investors are willing to commit funds to stocks.

Answer 13

What is Risk Aversion?

Question 14

Bell-shaped probability distribution that characterizes many natural pheonmena

Answer 14

What is Normal Distribution?

Question 15

What are the items below describing?

• Symmetric
• Stable
• Only mean and standard deviation are needed to estimate future scenarios
• Statistical relation between returns can be summarized with a single correlation coefficient

Answer 15

Characteristics of Normal Distribution

Question 16

Standard measure of asymmetry in the probability distribution of returns

Answer 16

What is Skewness?

Question 17

The likelihood of extreme values on either side of the mean, smaller likelihood of moderate deviations.

Answer 17

What is Kurtosis?

Question 18

What are the items below describing?

• Loss that will be incurred in the event of an extreme adverse price change with some given, usually low, probability.
• Intuitively and inversely, it is how much we need to prepare for an extreme situation.

Answer 18

Value at Risk (VaR)

Question 19

What are the items below describing?

-Expected loss on a security conditional on returns being in the left tail of the probability distribution.

• Intuitively, it is how much we need to prepare for the situation that VaR cannot cover.

Answer 19

Expected Shortfalls (ES)