Reading 1, Time Value Of Money Flashcards
What is real risk-free interest rate?
The single period interest rate for a completely risk free security if no inflation were expected
What is inflation premium?
It compensates investors for expected inflation and reflects the average inflation rate expected over the maturity of a debt
What does nominal risk free interest rate consist of?
Inflation premium and real risk free rate
What is default risk premium?
It compensates investors for the possibility that the borrower will fail to make a promised payment at the contracted time and in the contracted amount
What is liquidity premium?
It compensates investors for the risk of loss relative to an investments fair value if the investment needs to be converted to cash quickly
What is maturity premium?
It compensates investors for the increased sensitivity of the market value of debt to a change in market interest rate as maturity is extended
What is simple interest rate?
It is only the interest times the principal. Compounding is excluded
What is the cash flow additivity principle?
It is the idea that amount of money indexed at the same point in time are additive
Interest rate can be said of being composed of a real risk free interest rate plus a set of four distinctive premiums that are compensation for bearing risk, name them.
- Inflation premium
- Default risk premium
- Liquidity premium
- Maturity premium
What is an ordinary annuity?
It is a finite set of level sequential cash flows with its first cash flow occurring one period from now.(indexed at t=1)
What is an annuity due?
It is a finite set of level sequential cash flows with its first cash flow occurring immediately. (Indexed at t=0)
What is a perpetuity?
It is a set of level never ending sequential cash flows, with the first cash flow occurring one period from now. (Indexed at t=1)
