Unit 4 Flashcards
Required Rate of Return
minimal annual percentage earned by investment that will induce individuals/companies to put money into particular securities/projects
Value Estimation
discount expected future cash flows back to today’s equivalent value at the rate of return that is appropriate given the investment’s risk
Rate of Return
Yield; interest rate
Yield
Earnings from an investment over specific period
Drivers of Market Interest Rate
inflationary expectations, risk of investment, liquidity, preference, deferred consumption
liquidity premium
perceived difficulty converting asset into money and into goods
Expectation Hypothesis
proposition that long-term rate is determined by market’s expectation for short-term risk and constant risk premium
Segmented Market Hypothesis
financial instruments of different terms not substitutable
Drivers behind inflation
cost push, demand pull, increase in money supply, decrease in money demand
Cost push
decrease in aggregate supply of goods and services from increase in cost of production; demand must be static
demand pull
increase in aggregate demand from expanding economy, increase in government spending, overseas growth; demand exceeds production; caused by increase in employment
Cost of money
Opportunity cost, interest
Time Value of Money
Money today is worth more than money in the future
Discounting
determining how much future cash flow is worth today
Costs that combine to determine interest rate
opportunity cost, inflation, risk, liquidity
Amortization
process of identifying payment amount for each period of repayment on debt; takes into account time value of money
Perpetuities
annuities that have no end; stream of cash payments that go on forever
Relationship between Present and Future Value
when one increases, the other increases; as interest rate and number of periods increases, future value increases and present value decreases
Major consideration in capital budgeting
risk
Beta
measure firms can use to determine investments return sensitivity in relation to overall market risk; higher beta tends to be riskier
Types of risk
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
Systematic Risk
market risks; risks that can affect an entire market of large percent of market; diversification has no impact on investments
Unsystematic Risk
specific risk; only affects an industry or particular company; change in management, product recall, regulatory change, new competitor in market
