FE_L1 (without appendix) Flashcards
What is the role of the financial system?
It allows for desynchronisation of income and consumption over time and across risk scenarios, enabling borrowing, saving, diversification, insurance, and hedging.
What is a financial asset?
A contract with future monetary rights/obligations (e.g., bonds, stocks, options). They often have no intrinsic material value but are tradable.
How do you define discounting and compounding?
Discounting finds the present value of a future payment by dividing by the growth factor. Compounding finds the future value by multiplying by the growth factor.
What is the present value of future payments?
The sum of each payment xt divided by (1 + r)t, where r is the per-period interest rate.
What is the difference between spot and forward rates?
Spot rate: the fixed rate for a zero-coupon bond to maturity.
Forward rate: the implied future rate for a specific period based on today’s information.
What is a yield to maturity (YTM)?
The constant interest rate y that equates a bond’s present value of future coupon and par value payments to its current price.
How to calculate the present value of a riskless sequence of payments (xt)?
PV(x) = ∑t=1N [ xt / Π(1+ri) ], summing all future payments with the appropriate discount factors.
Why is no asset truly riskless?
Because default or other risks always exist. Assets like government bonds are treated as nearly riskless but still carry some risk.
How to value an infinite annual dividend of 1000 CHF?
Use the perpetuity formula V0 = 1000 / r, where r is the discount rate.
What are the learning objectives of this lecture?
- Understand compounding and discounting
- Compute present values of payments and annuities
- Compute forward rates from the yield curve
- Understand the role of risk in valuation
