Quantitative Methods Flashcards
time value of money
A topic in investment mathematic that deals with equivalence relationships between cash flows with different dates.
Discount
In finance and investing, a discount refers to a situation when a security is trading for lower than its fundamental or intrinsic value.
Interest Rate
denoted r, is a rate of return that reflects the relationship between differently dated cash flows.
If $9500 today and $10000 in one year are equivalent in value
If $9,500 today and $10,000 in one year are equivalent in value, then $10,000 − $9,500 = $500 is the required compensation for receiving $10,000 in one year rather than now. The interest rate—the required compensation stated as a rate of return—is $500/$9,500 =
0.0526 or 5.26 percent
Opportunity Cost
Is the value that investor forgo by choosing a particular course of action
Example: if the party who supplied $9500 had instead decided to spend it today, he would have forgone earning 5.26% on the money
real risk-free interest rate
is the single period interest rate for a completely, risk fee security
inflation premium
compensates investors for expected inflation and reflects the average inflation rate expected over the maturity of the debt
nominal risk-free interest rate
The sum of the real risk-free rate and the inflation premium
default risk premium
compensates investors for the possibility that the borrower will fail to make a promised payment at the contracted time and in the contracted amount
liquidity premium
compensates investors for the risk of loss relative to an investment’s fair value if the investment need to be converted to cash quicklhy.
maturity premium
compensates investors for the increased sensitivity of the market value of debt to a change in market interest rates as maturity is extended, in general (holding all else equal)
present value(PV)
The current value of a future sum of money or steam of cash flow
Future Value (FV)
Will be received in N years or periods from today
Suppose you invest $100 (PV = $100) in an interest bearing bank account paying 5% annually. At the end of the first year you will have the $100 plus the interest earned, 0.05 x 100 = $5 for a total of $105. Formalize this one-period:
PV = present value of the investment
FV(n) = Future value of the invest N period from today
r = rate of interest period
for N = 1, the expression for the future value of amount PV is
FVv1=PV(1+r)
simple interest
Principal
Compounding
A Prior Probability
A probability based on logical analysis rather than on observation or personal judgement
Abnormal Return
The amount by which a security’s actual return differs from its expected return, given the security risk and the markets return
