Chapter 6

Question 1

Real interest rate

Answer 1

The underlying interest rate with no inflation or uncertainty about future cash flows

Question 2

Inflation

Answer 2

Increase in the level of prices as a result of changes in demand or money supply

Question 3

Consumer Price Index (CPI)

Answer 3

Annual index updated quarterly that reflects changes in the general level of prices

Question 4

Risk-free

Answer 4

Free from default risk. A government Treasury bill is regarded as risk-free

Question 5

Risk premium

Answer 5

Additional return investors require for investing in risky assets

Question 6

Term structure of interest rates

Answer 6

Relationship between time to maturity and percentage yield

Question 7

Ex ante

Answer 7

Before the event

Question 8

Insolvent

Answer 8

The status of an individual or a company with insufficient assets to meet their financial commitments

Question 9

Business risk

Answer 9

Fluctuations in cash flows, such as sales

Question 10

Financial risk

Answer 10

Relates to the amount of debt used to fund a firm’s operations

Question 11

Liquidity risk

Answer 11

The risk that an investor holding equity or fixed income investments in a company may be unable to sell them to another investor

Question 12

Exchange rate risk

Answer 12

The risk associated with fluctuations in exchange rates

Question 13

Offshore currency

Answer 13

The monetary medium of exchange relating to other countries

Question 14

Country risk

Answer 14

Refers to the uncertainty of returns from investments in another country

Question 15

Debenture

Answer 15

A medium to long term loan agreement secured by assets of the borrower

Question 16

Risk aversion

Answer 16

The avoidance of risk

Question 17

Ex post

Answer 17

After the event

Question 18

Holding period return

Answer 18

Change in the value of an investment over the period it was owned

Question 19

Annual holding period yield

Answer 19

The annual percentage return received on an investment

Question 20

Capital gain

Answer 20

Amount by which the selling price of an asset exceeds its purchase price

Question 21

Capital loss

Answer 21

Amount by which the selling price of an asset is below its purchase price

Question 22

Variance

Answer 22

The variance measures how far each return is from the mean, or average, of all returns

Question 23

Standard deviation

Answer 23

The standard deviation measures the variability of a set of values

Question 24

Diversify

Answer 24

Place funds in a range of assets in order to spread risk

Question 25

Diversification

Answer 25

Practice of spreading risk by investing in a number of different assets

Question 26

Correlation

Answer 26

A measure of the relationship between two sets of variables

Question 27

Unsystematic risk

Answer 27

Risk that can be diversified away

Question 28

Systematic risk

Answer 28

Risk that cannot be diversified away because it pertains to the market

Question 29

Beta

Answer 29

Beta measures the volatility of an individual security or portfolio in relation to the market

Question 30

Capital asset pricing model (CAPM)

Answer 30

The CAPM calculates the required rate of return for any risky asset

Question 31

Market risk premium (MRP)

Answer 31

The additional return investors must earn to compensate them for investing in the market portfolio

Question 32

Market portfolio

Answer 32

The portfolio containing all risky assets

Question 33

Security market line (SML)

Answer 33

The SML displays the expected return of an individual security or portfolio in relation to its systematic, non diversifiable risk