FIN 310 Exam 2

Realized Return

Measures the gain or loss on an investment

Expected Return

What the investor expects to earn from an investment in the future

Risk

The degree of variability of possible outcome over time

Efficient Market Hypothesis (EMH)

States that securities prices accurately reflect future expected cash flows and are based on all information available to investors

Total Risk = systematic risk + unsystematic risk

Total risk formula

Systematic risk

Risk that cannot be eliminated through diversification

Unsystematic risk

Risk that can be eliminated through diversification

Beta coefficient

Measures the extent to which a particular investment's returns vary with the returns on the market portfolio

Beta = 1

Beta coefficient if the stock moves along with the market

Beta > 1

Beta coefficient if a stock's price is more volatile than the market

Beta < 1

Beta coefficient is steadier than the market

Capital Asset Pricing Model (CAPM)

Describes how the betas relate to the expected rates of return that investors require on their investments

Security Market Line (SML)

The straight-line relationship between the betas and expected returns. It is a graphic representation of the CAPM

Private debt

Loans from a financial institution

Public debt

bonds traded in the public financial markets

Underwriting

assuming risk of selling a security issued

Roles taken on by an investment banker

Underwriting, distributing, advising

corporate bond

a security sold by corporation that has promised future payments and a maturity date

Equity risk premium

The difference between the returns of the riskier stock investments and the less risky investments in government securities

Weak form

This form of efficient market hypothesis asserts that all past security market information is fully reflected in securities prices

semi strong form

This form of efficient market hypothesis asserts that all publicly available information is fully reflected in securities prices

Strong form

this form of efficient market hypothesis asserts that all information, whether public or private, is fully reflected in securities prices

Call provision

gives the issuer the right to redeem or pay off the bond before its scheduled maturity date

Conversion feature

lets the holder exchange their debt instrument (the bond) for a predetermined number of shares of the issuing company's common stock

climbs

When market interest rates rise, the required rate of return on common stock…

Four principles of bond valuation

1. The value of the bond is inversely related to changes in the market’s required YTM.

2. The market value of a bond will be less than the par
   value (discount bond) if the market’s required rate
   of return is above the coupon interest rate and will
   be more than the par valued if the market’s required
   yield to maturity is below the coupon interest rate.

3. As the maturity date approaches, the market value
   of a bond approaches its par value.

4. Long-term bonds have greater interest rate risk than short term bonds. Prices of long-term bonds fluctuate more than short-term bonds with changes in interest rates.