Compound Interest
The situation in which interest is paid on an investment during the first period is added to the principal. During the second period interest is earned on the original principal plus the interest earned during the first period.
Annuity
A series of equal dollar payments made for a specified number of years.
Annuity Due
An annuity in which the payments occur at the beginning of each period.
Perpetuity
An annuity with an infinite life.
Amortized Loan
A loan that is paid off in equal periodic payments.
Risk
Potential variability in future cash flows.
Standard Deviation
A statistical measure of the spread of a probability distribution calculated by squaring the difference between each outcome and its expected value, weighting each value by its probability, summing overall possible outcomes, and taking the square root of
Company- Unique Risk
Unsystematic Risk- The risk related to an investment return that can be eliminated through diversification.
Market Risk
Systematic Risk- The risk related to an investment return that cannot be eliminated through diversification.
Diversification
Holding a variety of securities to reduce the overall risk of a portfolio.
Holding Period Return
The return an investor would receive from holding a security for a designated period of time.
Beta
The relationship between an investment's returns and the market's returns. This is a measure of the investment's non-diversifiable risk.
Portfolio Beta
The relationship between a portfolio's reutrns and the market's returns. This is a measure of the portfolio's non-diversifiable risk.
Asset Collection
Identifying and selecting the asset classes appropriate for a specific investment portfolio and determining the proportions of those assets within the portfolio.
Required Rate of Return
Minimum rate of return necessary to attract an investor to purchase or hold a security.
Risk Premium
The additional return expected for assuming risk.
= Required Rate of Return - Risk Free Rate of Return
CAPM
Capital Asset Pricing Model - An equation stating that the expected rate of return on a project is a function of (1) the risk free rate, (2) the investment's systematic risk, and (3) the expected risk premium for the market portfolio of all risky securiti
Security Market Line
The return line that reflects the attitudes of investors regarding the minimum acceptable return for a given level of systematic risk associated with a security.
Bond
A long term (10 year or more) promissory note issued by the borrower, promising to pay the owner of the security a predetermined, fixed amount of interest each year.
Debenture
Any unsecured long term debt.
Subordinated Debenture
A debenture that is subordinated to other debentures in terms of its payments in case of insolvency.
Mortgage Bond
A bond secured by a lien on real property.
Euro Bond
A bond issued in a country different from the one in which the currency of the bond is denominated.
Zero Coupon
A bond issued at a substantial discount from its $1000 face value and that pays little or no interest
Junk Bond
Any bond rated BB or below.
Convertible Bond
A debt security that can be converted into a firms stock at a pre-specified price
Par Value
On the face of a bond, the stated amount that the firm is to repay upon the maturity date.
Coupon Interest Rate
The interest rate contractually owed on a bond as a percent of its par value.
Maturity
The length of time until the bond issuer returns the par value to the bondholder and terminates the bond.
Call Provision
Callable Bond- Issuer can redeem bond before if matures
Indenture
The legal agreement between the firm issuing bonds and the bond trustee who represents the bondholders, providing the specific terms of the loan agreement.
Bond Ratings
AAA, AA, A, BBB, BB, B, CCC, CC, C, D
Book Value
The value of an asset as shown on the firm's balance sheet.
Liquidation Value
The dollar sum that could be realized if an asset were sold.
Market Value
The value observed in the marketplace.
Intrinsic Value
Economic Value- The present value of an asset's expected future cash flows (fair value).
Value of an Asset
Present Value
Yield to Maturity
Expected Rate of Return- The rate of return a bondholder will receive if the bond is held to maturity.
Current Yield
The ratio of a bond's annual interest payment to its market price.
3 Bond Value Relationships
As interest rates increase, the value of the bond decreases. The market value of a bond will be less than the par value if the required rate of return of investor's is above the coupon interest rate. Long term bonds have greater interest rate risk than sh
Interest Rate Risk
The variability in a bond's value caused by changing interest rates.
Discount Bond
A bond that sells at a discount, or below par value.
Premium Bond
A bond that is selling above its par value.