Unit 4

Question 1

Required Rate of Return

Answer 1

minimal annual percentage earned by investment that will induce individuals/companies to put money into particular securities/projects

Question 2

Value Estimation

Answer 2

discount expected future cash flows back to today’s equivalent value at the rate of return that is appropriate given the investment’s risk

Question 3

Rate of Return

Answer 3

Yield; interest rate

Question 4

Yield

Answer 4

Earnings from an investment over specific period

Question 5

Drivers of Market Interest Rate

Answer 5

inflationary expectations, risk of investment, liquidity, preference, deferred consumption

Question 6

liquidity premium

Answer 6

perceived difficulty converting asset into money and into goods

Question 7

Expectation Hypothesis

Answer 7

proposition that long-term rate is determined by market’s expectation for short-term risk and constant risk premium

Question 8

Segmented Market Hypothesis

Answer 8

financial instruments of different terms not substitutable

Question 9

Drivers behind inflation

Answer 9

cost push, demand pull, increase in money supply, decrease in money demand

Question 10

Cost push

Answer 10

decrease in aggregate supply of goods and services from increase in cost of production; demand must be static

Question 11

demand pull

Answer 11

increase in aggregate demand from expanding economy, increase in government spending, overseas growth; demand exceeds production; caused by increase in employment

Question 12

Cost of money

Answer 12

Opportunity cost, interest

Question 13

Time Value of Money

Answer 13

Money today is worth more than money in the future

Question 14

Discounting

Answer 14

determining how much future cash flow is worth today

Question 15

Costs that combine to determine interest rate

Answer 15

opportunity cost, inflation, risk, liquidity

Question 16

Amortization

Answer 16

process of identifying payment amount for each period of repayment on debt; takes into account time value of money

Question 17

Perpetuities

Answer 17

annuities that have no end; stream of cash payments that go on forever

Question 18

Relationship between Present and Future Value

Answer 18

when one increases, the other increases; as interest rate and number of periods increases, future value increases and present value decreases

Question 19

Major consideration in capital budgeting

Answer 19

risk

Question 20

Beta

Answer 20

measure firms can use to determine investments return sensitivity in relation to overall market risk; higher beta tends to be riskier

Question 21

Types of risk

Answer 21

Systematic or unsystematic risk, business risk, credit/default risk, country risk, foreign exchange risk, interest rate risk, political risk, counterparty risk, liquidity risk, model risk

Question 22

Systematic Risk

Answer 22

market risks; risks that can affect an entire market of large percent of market; diversification has no impact on investments

Question 23

Unsystematic Risk

Answer 23

specific risk; only affects an industry or particular company; change in management, product recall, regulatory change, new competitor in market