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Ch 4: Return and Risk
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Terms in this set (46)
income
usually cash or near-cash that is periodically received as a result of owning an investment
total return
the sum of the current income and the capital gain (or loss) earned on an investment over a specified period of time
expected return
the return an investor thinks an investment will earn in the future
inflation
a period of generally rising prices
deflation
a period of generally declining prices
satisfactory investment
an investment whose present value of benefits (discounted at the appropriate rate) equals or exceeds the present value of its costs
nominal rate of return
the actual return earned on an investment expressed in current dollars
real rate of return
the nominal return minus the inflation rate; a measure of the increase in purchasing power that an investment provides
return equation
real return = nominal return - inflation rate
required return
the rate of return an investor must earn on an investment to be fully compensated for its risk
expected inflation premium
the average rate of inflation expected in the future
risk-free rate
the rate of return that can be earned on a risk-free investment; the sum of the real rate of return and the expected inflation premium
risk premium
a return premium that reflects the issue and issuer characteristics associated with a given investment vehicle
holding period
the period of time over which one wishes to measure the return on an investment vehicle
realized return
current income actually received by an investor during a given period
paper return
a return that has been achieved but not yet realized by an investor during a given period
holding period return (HPR)
the total return earned from holding an investment for a specified holding period (usually 1 year or less)
internal rate of return (IRR)
the discount rate that equates the investment's cost to the present value of the benefits that it provides for the investor
reinvestment rate
the rate of return earned on interest or other income received from an investor over its investment horizon
fully compounded rate of return
the rate of return that includes interest earned on interest
rate of growth
the compounded annual rate of change in the value of a stream of income
risk-return tradeoff
the relationship between risk and return, in which investments with more risk should provide higher returns, and vice versa
business risk
the degree of uncertainty associated with an investment's earnings and the investment's ability to pay the turns owed to investors
financial risk
the degree of uncertainty of payment resulting from a firm's mix of debt and equity; the larger the proportion of debt financing, the greater this risk
purchasing power risk
the chance that unanticipated changes in price levels (inflation or deflation) will adversely affect investment returns
interest rate risk
the chance that changes in interest rates will adversely affect a security's value
liquidity risk
the risk of not being able to liquidate an investment quickly and at a reasonable price
tax risk
the chance that Congress will make unfavorable changes in tax laws, driving down the after-tax returns and market values of certain investments
event risk
risk that comes from an unexpected event that has a significant and usually immediate effect on the underlying value of an investment
market risk
risk of decline in investment returns because of market factors independent of the given investment
standard deviation, s
a statistic used to measure the dispersion (variation) of returns around an asset's average or expected return
risk-indifferent investors
an investor who does not require a change in return as compensation for greater risk
risk-averse investors
an investor who requires greater return in exchange for greater risk
risk-seeking investor
an investor who will accept a lower return in exchange for greater risk
time value of money
the fact that as long as an opportunity exists to earn interest, the value of money is affected by the point in time when the money is received
interest
the "rent" paid by a borrower for use of the lender's money
simple interest
interest paid only on the initial deposit for the amount of time it is held
compound interest
interest paid not only on the initial deposit but also on any interest accumulated from one period to the next
true rate of interest
the actual rate of interest earned
continuous compounding
interest calculation in which interest is compounded over the smallest possible interval of time
future value
the amount to which a current deposit will grow over a period of time when it is placed in an account paying compound interest
annuity
a stream of equal cash flows that occur at equal intervals over time
ordinary annuity
an annuity for which the cash flows occur at the end of each period
present value
the value today of a sum to be received at some future date; the inverse of future value
discount rate
the annual rate of return that could be earned currently on a similar investment; used when finding present value; also called opportunity cost
mixed stream
a stream of returns that, unlike an annuity, exhibits no special pattern
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