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FIN 324 - Ch. 4

Terms in this set (44)

Return
the level of profit from an investment—that is, the reward for investing.
Income
cash the investors periodically receive as a result of owning an investment
Capital gains (or losses)
the difference between the proceeds from the sale of an investment and its original purchase price
Total return
the sum of the income and the capital gain (loss) earned on an investment over a specified period of time.
rate of return
indicates how rapidly an investor can build wealth
Historical performance
provides a basis for future expectations, but doesn't guarantee performance
expected return
Return an investor thinks an investment will earn in the future
higher
inflation ___________, higher rate of return
direct
what relationship do inflation and rate of return have?
time value of money
It is generally better to receive cash sooner rather than later
satisfactory invesment
one for which the present value of benefits (discounted at the appropriate discount rate) equals or exceeds the present value of its costs.
Exceeds
If the present value of the benefits ___________ the cost, you earn a rate of return greater than the discount rate.
Nominal rate of return
the return that the investment earns expressed in current dollars. It does not take into account the effects of inflation.
Real rate of return
measures the increase in purchasing power that the investment provides
real return
Nominal return - inflation rate =
risk adverse
they do not like risk and will only take risk when they expect compensation for doing so
required return
the rate of return that fully compensates for an investment's risk
required return on investment
real return + expected inflation premium + risk premium for investment =
expected inflation premium
the rate of inflation expected over an investment's life
risk-free rate
rate of return that can be earned on a risk-free investment, such as a short-term U.S. Treasury bill.
risk free rate
real rate of return + expected inflation premium =
risk premium
additional return an investor requires on a risky investment to compensate for risks based upon issue and issuer characteristics
required return on investment
risk-free rate + risk premium for investment
holding period
the period of time over which one wishes to measure the return on an investment.
realized return
income received by the investor during the investment period
paper return
the capital gain or loss that has been achieved but not yet realized (no sale has taken place)
short term
______________ investments look at holding period return
Holding period return (HPR)
(income during period + capital gain/loss)/ beginning investment value
Internal rate of return
The discount rate that equates an 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 investment over its investment horizon.
fully compounded rate of return
is the rate of return that includes interest earned on interest.
rate of growth
The compound annual rate of change in some financial quantity, such as the price of a stock or the size of its dividend.
risk
the uncertainty surrounding the actual return that an investment will generate.
risk return tradeoff
the relationship between risk and return in which investors want to obtain the highest possible return for the level of risk that they are willing to take.
business risk
the degree of uncertainty associated with an investment's earnings and the investment's ability to pay the returns (interest, principal, dividends) that investors expect.
financial risk
the increased uncertainty that results when a firm borrows money.
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 sell an investment quickly without reducing its 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 occurs when an unexpected event has a significant and unusually immediate effect on the underlying value of an investment
market risk
the risk that investment returns will decline because of factors that affect the broader market, not just one company or one investment.
standard deviation
An indicator of an asset's risk, it measure the dispersion (variation) of returns around an asset's average or expected return.
risk neutral
describes an investor who does not require a change in return as compensation for greater risk.
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