Finance Chapter 6/7 Terms

Risk

Risk

Degree of uncertainty of return on an asset; in business, the likelihood of loss or reduced profit.

standard deviation

a computed measure of how much scores vary around the mean score

Company-unique risk

the risk related to an investment return that can be eliminated through diversification (diversifiable)

market risk

risk that affects all companies in the stock market (nondiversifiable)

Diversification

Spreading out investments to reduce risk

Holding period returns

the rate of return earned on an investment, which equals the dollar gain divided by the amount invested

Beta

It is a measure of how an individual's stocks returns vary with market returns. Measure of the "sensitivity"

Portfolio Beta

the relationship between a portfolio's returns and the market returns. It is a measure of the portfolio's nondiversifiable risk

Asset allocation

allocation of an investment portfolio across broad asset classes

risk-free rate of return

the rate of return on risk-free investments. The interest rates on short-term U.S. government securities are commonly used to measure this rate

required rate of return

minimum rate of return necessary to attract an investor to purchase or hold a security

expected rate of return

The increase in profit a firm anticipates it will obtain by purchasing capital (or engaging in research and development); expressed as a percentage of the total cost of the investment (or R&D) activity.

risk premium

the excess return required from an investment in a risky asset over that required from a risk-free investment

Capital Asset Pricing Model (CAPM)

a model that relates the required rate of return on a security to its systematic risk as measured by beta

Security Market Line

a positively sloped straight line displaying the relationship between expected return and beta

bond

A financial security that represents a promise to repay a fixed amount of funds

Debenture

an unsecured debt, usually with a maturity of 10 years or more

mortgage bond

A bond backed by fixed assets. First mortgage bonds are senior in priority to claims of second mortgage bonds.

Eurobond

bond denominated in a currency other than that of the country in which it is sold

convertible bonds

Bonds that can be converted into common stock at the bondholder's option

par value

a value assigned to a share of stock and printed on the stock certificate

coupon interest rate

the stated annual interest rate on a bond

Fixed Rate Bond

a bond that pays a fixed amount of interest to the investor each year

zero coupon bond

a bond that makes no coupon payments and is thus initially priced at a deep discount

Maturity

the time at which payment to a bondholder is due

callable bonds

bonds that the issuing company can redeem (buy back) at a stated dollar amount prior to maturity

call protection period

a prespecified time period during which a company cannot recall a bond

indenture

the written agreement between the corporation and the lender detailing the terms of the debt issue

junk bonds

High-risk, high-interest bonds

Bond Ratings

A rating assigned to a firm to measure the probability of default by a company like S&P or Moody's.

Book Value

the difference between the cost of a depreciable asset and its related accumulated depreciation

liquidation value

net amount that can be realized by selling the assets of a firm and paying off the debt

Market Value

observed value of an asset, determined by S&D

intrinsic value

An estimate of a stock's "true" value based on accurate risk and return data. Can be estimated but not measured precisely.

efficient value

the accuracy of the predicted return on the investment.

yield to maturity

the rate required in the market on a bond

Current yield

a bond's annual coupon divided by its price

3 bond value relationships

As interest rates increase, the value of the bond decreases. The market value of a bond will be less than the par value if the required rate of return of investor's is above the coupon interest rate. Long term bonds have greater interest rate risk than short term bonds.

interest rate risk

the risk of capital losses to which investors are exposed because of changing interest rates

discount bond

the difference between the face value of a bond and its selling price when a bond is sold for less than its face value

premium bond

The difference between the selling price and the face value of a bond when a bond is sold for more than its face value.