Business Finance Chapter 4

Real Asset

Physical asset used to produce goods or services (e.g., land, buildings, machinery)

Financial Asset

A claim on the income or value of a real asset (e.g., stocks, bonds)

Debt

A contract requiring fixed payments over time (interest + principal)

Money Market

Market for short-term debt securities (maturity ≤ 1 year)

Capital Market

Market for long-term securities (stocks and long-term bonds)

Equity

Ownership in a company with no guaranteed payments (stocks)

Derivative

A contract whose value depends on another asset (e.g., options, futures)

Risk

The chance of losing money or earning less than expected

Stand-alone Risk

The risk of a single investment measured by volatility (standard deviation)

Correlation

A measure of how two assets move in relation to each other

Risk Premium

Extra return earned for taking on risk (risky return − risk-free rate)

Inflation

Decrease in purchasing power over time

Real Rate of Interest

Growth rate of purchasing power

Nominal Rate of Interest

Growth rate of money (stated interest rate)

Yield Curve

Graph showing interest rates across different maturities

Default Risk

Risk that the borrower fails to make required payments

Interest Rate Risk

Risk that rising interest rates reduce bond value

Par Bond

A bond selling at its face value

Discount Bond

A bond selling below its face value

Premium Bond

A bond selling above its face value

Coupon

Periodic interest payment made to bondholders

Face Value

Amount repaid at maturity (usually $1,000)

Maturity Date

Date when the bond’s principal is repaid

Coupon Rate

Interest rate stated on the bond

Yield

Actual rate of return earned on a bond

Call Provision

Allows issuer to repay the bond before maturity

Retained Earnings

Profits kept in the business for reinvestment

Dividend

Cash payment made to shareholders

Share Repurchase

Company buys back its own shares from the market

Market Risk Premium

Extra return expected from the market over the risk-free rate

Idiosyncratic Risk

Company-specific risk that can be diversified away

Systematic Risk

Market-wide risk that cannot be eliminated

Beta

Measure of a stock’s systematic risk relative to the market

CAPM

Model that relates expected return to risk (beta, risk-free rate, market premium)

Security Market Line

Graph showing relationship between beta and expected return

Intrinsic Value

The true value of a stck based on future cash flows

Preferred Stock

Hybrid security with fixed dividends and priority over common stock