Final Flashcards
What is an opportunity cost rate?
The rate of return that is expected if an alternative investment were taken that is similar in risk.
What is the difference between a lump sum, annuity, and uneven cash flows?
Lump sum- One large payment at the beginning.
Annuity- Annual payments of an equal amount.
Uneven Cash Flows- Annuity with varying amounts.
What are the two types of annuities, and what is the difference?
Ordinary- Payment made at the end of the year.
Annuity Due- Payment made at the beginning of the year.
Would you rather have a savings account that compounds annually, monthly, weekly, or daily? Why?
Daily because the more an account compounds, the more potential to make money on interest.
When a loan is amortized, what happens over time to the size of the payment, principle, and interest?
Payment- Remains the same
Principle- Grows over time
Interest- Decreases over time
Explain the difference between the stated rate, period rate, and effective annual rate.
Stated Rate- The annual rate
Period Rate- The stated rate/# periods (typically months)
Effective Annual Rate- Produces the same number of periods as monthly compounding.
Explain why holding investments in portfolios has such a profound impact on the concept of financial risk.
When an investment is held in a portfolio, the concern becomes about the riskiness of the portfolio as a whole, and not the individual investment.
Define Stand-alone Risk, Diversifiable Risk, and Portfolio Risk.
Stand-alone- Risk of an investment held in isolation
Diversifiable- Risk can be eliminated by diversification
Portfolio- Risk cannot be eliminated by diversification
Is it possible for the risk of a portfolio to be lower than the risk of either investment?
Yes, when investments are diversified in a portfolio the portfolio can be lower than either individual investment.
Is it possible for a portfolio to be riskless?
No
What is expected rate of return vs. required rate of return?
Expected rate of return is what you expect to get back from a specific investment.
Required rate of return is what you need to get back to make the investment worthwhile.
What is a yield curve?
A plot of the term structure of interest rates.
What are the names of the three bond rating agencies?
Fitch, Moody’s, and S&P
What do bond ratings measure?
The quality of the investment by calculating the probability of the bond going into default.
What is credit enhancement?
Bond insurance that guarantees the payment of interest and repayment of principle on a bond, even if the company defaults.
