FIN302: Investments - Assignment 1 Concepts and Formulas

Vocabulary flashcards covering financial market concepts, fixed income yield calculations, probability distributions of returns, complete portfolio construction, and risk-reward metrics from FIN302 Assignment 1.

Financial Assets

Securities that represent claims on real assets or cash flows, which include debt securities, equity securities, and derivative securities.

Financial Intermediaries

Institutions that channel funds between lenders and borrowers in the economy, including commercial banks, insurance companies, investment companies, and mortgage brokers.

Functions of Financial Markets

Economic mechanisms that allow investors to shift consumption over time, price securities according to riskiness, and allocate capital from savers to borrowers.

Equivalent Taxable Yield

The pretax return required on a taxable bond to equal the after-tax return of a tax-exempt municipal bond, calculated as: $\frac{r_m}{1 - t}$ where $r_m$ is the municipal bond yield and $t$ is the combined tax bracket.

Bank Discount Ask Yield (T-Bill Price Formula)

The pricing convention for Treasury bills based on face value and a 360-day year: $\text{Price} = \text{Face Value} \times \left(1 - \text{Bank Discount Yield} \times \frac{\text{Days to Maturity}}{360}\right)$

Bond Equivalent Yield (BEY)

An annualized yield on short-term discount instruments calculated using actual purchase price and a 365-day year convention: $\text{BEY} = \frac{\text{Face Value} - \text{Purchase Price}}{\text{Purchase Price} \times \left(\frac{\text{Days to Maturity}}{365}\right)}$

Expected Return ($E(r)$)

The probability-weighted mean of potential holding period returns across all economic scenarios: $E(r) = \sum_{s=1}^{S} p(s)r(s)$ where $p(s)$ is the probability and $r(s)$ is the holding period return of scenario $s$.

Variance of Return ($\operatorname{Var}(r)$)

The expected value of squared deviations of returns from the mean return: $\operatorname{Var}(r) \equiv \sigma^2 = \sum_{s=1}^{S} p(s)\left[r(s) - E(r)\right]^2$

Standard Deviation of Return ($\operatorname{SD}(r)$)

A common measure of risk representing the dispersion of returns, defined as the square root of variance: $\operatorname{SD}(r) \equiv \sigma = \sqrt{\operatorname{Var}(r)}$

Risk Premium

The excess return demanded by investors over the risk-free rate to compensate for bearing investment risk, calculated such that: $E(r) = r_f + \text{Risk Premium}$ where $r_f$ is the risk-free rate.

Complete Portfolio Expected Return ($E(r_C)$)

The weighted average expected rate of return for a portfolio formed by allocating fraction $y$ to a risky portfolio and fraction $(1 - y)$ to a risk-free asset: $E(r_C) = y \times E(r_P) + (1 - y) \times r_f$

Complete Portfolio Standard Deviation ($\sigma_C$)

The total risk of a combined risky and risk-free asset allocation, which equals the proportion invested in the risky portfolio multiplied by its standard deviation: $\sigma_C = y \times \sigma_P$

Reward-to-Volatility (Sharpe) Ratio

A performance metric measuring the excess return per unit of portfolio volatility: $\text{Reward-to-Volatility Ratio} = \frac{\text{Portfolio Risk Premium}}{\text{Standard Deviation of Excess Return}} = \frac{E(r_P) - r_f}{\sigma_P}$