Test 3 (Chapters 9-11)

Question 1

What is an opportunity cost?

Answer 1

It is the cost associated with alternative uses of the same funds.

Question 2

What is an annuity

Answer 2

It is a series of payments over a fixed period of time for a specific number of periods.

Question 3

What is an uneven cash flow stream?

Answer 3

This is when payments vary one from another in that they do not equal the same amount each time

Question 4

What is a stated rate?

Answer 4

It is the interest rate stated in the debt contract

Question 5

What is an effective annual rate?

Answer 5

It is the interest rate that, under annual compounding, produces the same future value as was produced bu more frequent compounding.

Question 6

What is the periodic rate?

Answer 6

It is the interest rate per period stated.

Question 7

What sorts of things make stocks more risky? Is it a higher rate or return, standard deviation, or beta?

Answer 7

As a general rule, The greater the standard deviation the greater the risk of the investment.

Question 8

Is it possible for a portfolio to be riskless?

Answer 8

Conceptually, yes, but the portfolio would have no have zero correlation to market movements to be riskless.

Question 9

What is portfolio risk?

Answer 9

The riskiness of an individual investment when it is part of a diversified portfolio as opposed to being held in isolation.

Question 10

What is diversifiable risk?

Answer 10

The portion of risk in an investment that can be eliminated by holding the investment as paort of a diversified portfolio

Question 11

What are the 2 types of portfolio risk?

Answer 11

Corporate risk, which is the risk of business projects when considered as part of a business’s portfolio of projects, and market risk, which is risk of business projects when considered as part of an individual investors portfolio of securities

Question 12

What is CAPM?

Answer 12

CAPM stands for the capital asset pricing model and it is an equilibrium model that describes the relationship between market risk and required rates of return.

Question 13

What is the SML?

Answer 13

The security market line provides the actual risk/required rate of return relationship for CAPM.

Question 14

What are the 4 fundamental factors that affect supply and demand of investment capital?

Answer 14

investment opportunities, time preference for consumption, risk, and inflation

Question 15

What is a yield curve?

Answer 15

It is a plot of the term structure of interest rates (yield to maturity vs. term to maturity)

Question 16

What is a term loan?

Answer 16

Long-term debt obtained directly from a bank

Question 17

What is a bond?

Answer 17

Long-term debt issued by a business or government and is generally sold to a large number of individual investors.

Question 18

What is a mortgage bond?

Answer 18

A bond issued by a business that pledges real property (land and buildings) as collateral

Question 19

What is a debtenture?

Answer 19

It is an unsecured bond given by businesses with very strong financial health that don’t need to offer any collateral.

Question 20

What is an indenture?

Answer 20

The loan agreement

Question 21

What is a call provision?

Answer 21

A loan agreement that gives the issuing company the right to redeem bonds before maturity.

Question 22

What is credit enhancement?

Answer 22

Insurance that guarantees the payment of interest and repayment of principal on a bond even if defaulted.

Question 23

What 3 factors influence interest rates?

Answer 23

federal reserve policy, federal budgetary policy, and the overall level of economic activity.

Question 24

What is interest rate risk?

Answer 24

Risk to current debt holders that stems from interest rate changes

Question 25

What is price risk?

Answer 25

The risk that, with increasing interest rates, bondholders may face the risk of losses in holdings.

Question 26

What is reinvestment risk?

Answer 26

The risk that, if interest rates fall, bondholder will earn a lower rate on the reinvested cash flows.