Final Exam Study Guide Test Chapters 4 6 10 and 12 of Gitman and Joehnk Test Date Thursday August 4 2011 at 11 15am Chapter 4 Review Vocabulary investing 1 Return The level of profit from an investment that is the reward for 2 Current Income Usually cash or near cash that is periodically received as a result of owning an investment 3 Total Return The sum of the current income and the capital gain or loss earned on an investment over a specified period of time 4 Expected Return The return an investor thinks an investment will earn in the future Inflation A period of generally rising prices 5 6 Deflation A period of generally declining prices 7 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 8 9 Simple Interest Interest paid only on the initial deposit for the amount of time it is held 10 True rate of interest return The actual rate of interest earned 11 Compound interest Interest paid not only on the initial deposit but also on any interest accumulated from one period to the next 12 Continuous Compounding Interest calculation in which interest is compounded over the smallest possible interval of time 13 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 14 Annuity A stream of equal cash flows that occur at equal intervals over time 15 Ordinary Annuity An annuity for which the cash flows occur at the end of the 16 Present Value The value today of a sum to be received at some future date period the inverse of future value 17 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 18 Mixed Stream A stream of returns that unlike an annuity exhibits no special pattern 19 Satisfactory Investment An investment whose present value of benefits discounted at the appropriate rate equals or exceeds the present value of its costs 20 Required Return The rate of return an investor must earn on an investment to be fully compensated for its risk 21 Real rate of return The rate of return that could be earned in a perfect world where all outcomes are known and certain where there was no risk 22 Expected Inflation Premium The average rate of inflation expected in the future 23 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 24 Risk Premium A return premium that reflects the issue and issuer characteristics associated with a given investment vehicle 25 Holding period The period of time over which one wishes to measure the return on an investment vehicle 26 Realized Return Current income actually received by an investor during a given period 27 Paper Return A return that has been achieved but not yet realized by an investor during a given period 28 Holding Period Return HPR The total return earned from holding an investment for a specified holding period usually a year or less 29 Yield Internal Rate of Return The compound annual rate of return earned by a long term investment the discount rate that produces a present value of the investment s benefits that just equals its costs 30 Reinvestment Rate The rate of return earned on interest or other income received from an investment over its investment horizon 31 Fully compounded rate of return The rate of return that includes interest 32 Rate of Growth The compound annual rate of change in the value of a stream 33 Risk The chance that the actual return from an investment may differ from 34 Risk return Tradeoff The relationship between risk and return in which investments with more risks should provide higher returns and vice versa 35 Business Risk The degree of uncertainty associated with an investment s earning and the investment s ability to pay the returns owed to investors 36 Financial Risk The degree of incertainty of payment attributable to the mix of debt and equity used to finance a business the larger the proportion of debt financing the greater this risk 37 Purchasing Power Risk The chance that changing price levels inflation or deflation will adversely affect investment returns 38 Interest Rate Risk The chance that changes in interest rates will adversely affect a security s value 39 Liquidty Risk the risk of not being able to liquidate an investment conveniently and at a reasonable price 40 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 41 Market Risk Risk of decline in investment returns because of market factors independent of the given investment 42 Event Risk Risk that comes from an unexpected event that has a significant and usually immediate effect on the underlying value of an investment earned on interest of income what is expected 43 Standard Deviation s A statistic used to measure the dispersion variation of returns around an asset s average or expected return 44 Coefficient of Variation CV A statistic used to measure the relative dispersion of an asset s returns it is useful in comparing the risk of assts with differing average or expected returns 45 Risk Indifferent Described an investor who does not require a change in return as compensation for greater risk 46 Risk Adverse Described an investor who requires greater return in 47 Risk Seeking Describes an investor who will accept a lower return in exchange for greater risk exchange for greater risk Use his Excel Spreadsheet to Understand this chapters calculations Chapter 4 Book Notes Components of Return o Current Income o Capital Gains or Losses Historical Performance past data performance often provides a meaningful basis for future expectations Expected Return is a VITAL measure of performance Level of Return o Internal Characteristics Certain characteristics of an investment affect its level of return Examples Type of Investment Vehicle Quality of Management How the investment is financed The Customer base of the issue o External Forces May also affect the Level of Return Examples Federal Reserve Actions shortages war price controls and political events Simple Interest Most often used to calculate the income paid on investment vehicles that pay interest such as CDs and bonds o When an investment earns simple
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