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Gleim BEC > Study Unit 5 > Flashcards

Study Unit 5 Flashcards

1
Q

ROI

A

Amnt rec’d-Amnt invested

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2
Q

Rate of return

A

ROI/Amnt invested

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3
Q

Systematic risk

A

mkt risk (undiversifiable risk)
risk faced by all firms
changes in economy as a whole (inflation, business cycle)
all investments affected

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4
Q

Unsystematic risk

A

unique risk or company risk
determined by industry, products, customer loyalty, degree of leverage, mgt competence,

diversifiable risk

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5
Q

Types of investment risk

A 
credit default
liquidity
maturity (interest rate)
inflation
political
exchange 
business
country
principal
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6
Q

Credit default

A

risk borrower will default and won’t pay principal or interest; gauge by using credit-rating agencies

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7
Q

Liquidity

A

security can’t be sold on short notice for MV

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8
Q

Maturity risk

A

interest rate risk
risk an investment security will fluctuate n value bet date of issue and date of maturity
longer the date of maturity, higher the risk

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9
Q

Political risk

A

probability of loss from actions of govts (tax law changes, environmental regs)

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10
Q

Exchange rate risk

A

risk of loss bc of fluctuation in relative value of foreign currency

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11
Q

business risk

A

operation risk
risk of earning fluctuations before interest and taxes or in operating income when firm doesn’t use debt
-risk inherent in its ops that excludes financial risk (risk to shareholders from use of financial leverage)
-depends on demand variability, sales price variability, input price variability, amnt of op leverge

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12
Q

Country risk

A

overall risk of investing in a foreign country

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13
Q

principal risk

A

risk of losing the amnt invested

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14
Q

risk averse

A

utility of gain doesn’t outweigh dis utility of potential loss of the same amnt

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15
Q

risk neutral

A

investors adopts expected value approach bc they regard utility of gain as = to dis utility of a loss of same amnt

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16
Q

risk seeking

A

optimistic attitude toward risk

utility of gain as exceeding dis utility of loss of same amnt

17
Q

risk premium

A

excess of investment’s expected RoR over risk free interest rate (interest rate on safest investment, rate on US T bill)

T bill holder only exposed to inflation risk; mkt rate of interest = risk free rate of interest + inflation premium

18
Q

required rate of return

A

return that takes into account all investment risks that relate to specific security

Real risk free rate + inflation premium=risk free rate
risk free rate+ liquidity risk premium + default risk premium+ maturity risk premium= required rate of return

19
Q

Debt securities

A

income bonds pay return only if issuer is profitable
debentures are unsecured
mtg bonds are secured by real property
T bonds backed by US govt

20
Q

Precious metal

A

risky b/c of volatility

when high inflation, currency loses purchasing power & may be safe investment

21
Q

Probability distribution

A

set of all possible outcomes for decision

discrete b/c outcomes are limited

22
Q

expected rate of return

A

investment determined using an expected value calculation
avg of possible outcomes weighted wrt probabilities
Ex RoR= sum (possible rate of return * probability)

23
Q

Risk

A

chance actual return differs from expected
risk=std dev (variance) of investment’s return
std dev= sq rt[sum(possible rate of return-expected rate of return)^2 * probability]= sq rt (variance)

24
Q

Coefficient of variation

A

measures risk per unit of return
CV=std dev/expected rate of return
lower the ratio better the risk return tradeoff

25
Q

Diversification
expected portfolio return
portfolio risk

A

weighted avg of returns on indiv securities

less than a simple avg of the std deviations of component securities; benefit of diversification

benefits decrease when more than 20-30 different securities are held

26
Q

coefficient of correlation

A

measures degree to which any 2 variables (prices) are related

  • range from 1.0 to -1.0
  • perfect positive (1.0) means variables move together
  • perfect negative (-1.0) mans variables move opposite
  • normal range of 2 random stocks is .5 -.7
27
Q

CAPM

A

quantifies req ROE security by relating security’s level of risk to avg return available in the mkt (portfolio)
based on idea investor is compensated in 2 ways (time value of $ and risk)
-time value is risk free rate
-risk component consists of market risk premium (Rm-Rf) and beta

28
Q

market risk premium

A

return provided by mkt over and above risk free rate

varies in direct proportion to beta

29
Q

beta

A

measure of security’s risk

  • effect of indiv security on volatility measured by sensitivity to movements of overall mkt
  • beta of mkt=1, beta of US treasury = 0
30
Q

security risk premium

A

beta(Rm-Rf)

31
Q

CAPM formula

A

required RoR
Rf + beta(Rm-Rf)
Rm-market return

32
Q

derivative instrument

A

investment trans in which the gain or loss derived from some other economic event (price of stock, foreign currency exchange rate, price of commodity)
-one party enters into trans to speculate (incur risk) other enters into it to hedge (avoid risk)

33
Q

Hedging

A

offsetting instrument to minimize or avoid impact of adverse $ movement
-takes position correlated with original asset but in opposite direction
long position- entity owns asset, benefits when value increases
short position- entity sells asset it doesn’t own at time of
sale; take position when believe value will decrease (borrow asset from entity that owns it before “short sale”)

34
Q

Options

A

buyer holds all rights; seller has all of obligation
buyer pays fee to dictate in future whether seller buys or sells underlying asset from or to the buyer
holder- party buying option; exercise of option at holder’s discretion
writer- seller

35
Q

Exercise price

A

price holder can purchase (for call) or sell (put) the underlying asset
-increase in exercise price decreases value of call option and increase in value of put option

36
Q

Price of underlying

A

price increases, value or call increases; exercise price is greater bargain with each adtl dollar in price of underlying

value of put decrease as price of underlying increases, no advantage in selling at a lower than mkt price

37
Q

interest rate

A

rise in rate makes calls more attractive and increases value

rise in rate makes put option less attractive and decreases value

38
Q

Volatility of price of underlying

A

holder prefers greater volatility b/c more chance underlying price will change and option will be in-the-money
more volatile, increase value of option

39
Q

intrinsic value of a call option

A

amnt by which exercise price is less than current price of the underlying
positive i.v is in-the-money
0 i.v. out of the money

Gleim BEC (14 decks)

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