Chapter 6 Flashcards
Real interest rate
The underlying interest rate with no inflation or uncertainty about future cash flows
Inflation
Increase in the level of prices as a result of changes in demand or money supply
Consumer Price Index (CPI)
Annual index updated quarterly that reflects changes in the general level of prices
Risk-free
Free from default risk. A government Treasury bill is regarded as risk-free
Risk premium
Additional return investors require for investing in risky assets
Term structure of interest rates
Relationship between time to maturity and percentage yield
Ex ante
Before the event
Insolvent
The status of an individual or a company with insufficient assets to meet their financial commitments
Business risk
Fluctuations in cash flows, such as sales
Financial risk
Relates to the amount of debt used to fund a firm’s operations
Liquidity risk
The risk that an investor holding equity or fixed income investments in a company may be unable to sell them to another investor
Exchange rate risk
The risk associated with fluctuations in exchange rates
Offshore currency
The monetary medium of exchange relating to other countries
Country risk
Refers to the uncertainty of returns from investments in another country
Debenture
A medium to long term loan agreement secured by assets of the borrower
Risk aversion
The avoidance of risk
Ex post
After the event
Holding period return
Change in the value of an investment over the period it was owned
Annual holding period yield
The annual percentage return received on an investment
Capital gain
Amount by which the selling price of an asset exceeds its purchase price
Capital loss
Amount by which the selling price of an asset is below its purchase price
Variance
The variance measures how far each return is from the mean, or average, of all returns
Standard deviation
The standard deviation measures the variability of a set of values
Diversify
Place funds in a range of assets in order to spread risk
Diversification
Practice of spreading risk by investing in a number of different assets
Correlation
A measure of the relationship between two sets of variables
Unsystematic risk
Risk that can be diversified away
Systematic risk
Risk that cannot be diversified away because it pertains to the market
Beta
Beta measures the volatility of an individual security or portfolio in relation to the market
Capital asset pricing model (CAPM)
The CAPM calculates the required rate of return for any risky asset
Market risk premium (MRP)
The additional return investors must earn to compensate them for investing in the market portfolio
Market portfolio
The portfolio containing all risky assets
Security market line (SML)
The SML displays the expected return of an individual security or portfolio in relation to its systematic, non diversifiable risk
