Financial Risk Management Flashcards
3 types of Risk Preference behaviors
B6-36
- Risk-Indifferent Behavior- highest return period
- Risk-Averse Behavior -general rule
- Risk-Seeking Behavior
Risk Preference
define Risk-Indifferent Behavior
B6-36
An attitude where an increase in the level of risk does not result in an increase in management’s required return.
Risk Preference
define Risk-Averse Behavior
B6-36
An attitude where an increase in the level of risk results in an increase in management’s required rate of return
Risk Preference
define Risk-Seeking Behavior
B6-36
An attitude where an increase in the level of risk results in a decrease in management’s required rate of return
2 broad Categories of Risk are:
B6-36
D–Diversification
U—-unsystematic (nonmarket/firm specific)
N–Nondiversification- impacts everyone
S—-systematic (market)
Types of Risk (5):
B6-37
- Interest Rate (yield risk)
- Market
- Default
- Credit
- Liquidity
Interest Rate Risk (yeild risk)
B6-37
Exposure to loss as a result of increase or decrease in interest rates.
IR inc; Value of fixed rate bond dec
Market Risk
B6-37
Exposure of a security or firm to fluctuations in value as a result of operating within an economy.
–nondiversifiable
WFT inc; NASDAQ inc
Credit Risk
B6-38
the inability of an entity to secure debt financing in a timely or affordable manner as a result of poor credit rating.
–affects borrowers
Risk inc; IR inc
Default Risk
B6-38
potential that the debtors may not repay the principal or interest when due
–affects creditors
Liquidity Risk
B6-38
when lenders/investors desire to sell their security, but cannot do so in a timely manner or without making material price concessions.
–affects lenders (investors)
Stated Interest Rate
B6-39
interest rate before adj. for compounding or market factors
- aka- nominal interest rate
- the stated rate on the note
Effective Interest Rate
B6-39
the actual finance charge associated w/ borrowing after reducing loan proceeds for changes and fees related to a loan origination
*interest paid/net proceeds
Annual Percentage Rate
B6-39
A noncompounded version of the effective annual percentage rate
*Effective periodic rate x # compounding periods
Effective Annual Percentage Rate
B6-39
stated interest rate adj. for the number of compounding periods per year
*(1+stated rate)^#compound periods -1
Simple Interest
B6-40
interest paid only on the original amount of principal w/o regard to compounding
*principal x IR x #periods
Compound Interest
B6-40
interest earnings or expense that is based on the original principal plus any unpaid interest earnings or expense.
*principal x (1+IR)^#periods
Required Rate of Return
B6-41
maturity risk premium
+ purchasing power risk or inflation premium
+ liquidity risk premium
+ default risk premium
Factors Influencing FX
Trade Factors- relative inflation rate
B6-44
US inflation rate > Mexico inflation;
- US buys Pesos to maintain purchasing power
- demand of Peso inc; Pesos rises
Factors Influencing FX
Trade Factor- Relative Income Lvls
B6-44
Income lvls in US rise; FX changes
-demand for foreign currency inc; USD dec in relation to pesos
Factors Influencing FX
Trade Factors- Government Controls
B6-45
trade and exchange barriors (i.e. tarrifs) suppress the natural forces of supply and demand that affect FX.
Factors Influencing FX
Financial Factors- Relative IR and Capital Flows
B6-45
ROI inc in Mexico inc;
- US demand for Mex securities inc
- demand for peso inc
