Chapter 4 Return and Risk

Question 1

Return

Answer 1

The Level of profit from an investment, or the reward for investing.

Question 2

Income

Answer 2

cash that investors periodically receive as a result of owning an investment

Question 3

Total Return

Answer 3

combining the capital gain (or loss) with the income

Question 4

Expected Return

Answer 4

vital measure of performance, what you think the investment will earn in the future that determines what you should be willing to pay for it

Question 5

Inflation

Answer 5

price changes in an upward direction

Question 6

Deflation

Answer 6

price level heads in a downward direction

Question 7

Satisfactory Investment

Answer 7

the present value of benefits (discounted at the appropriate rate) equals or exceeds its cost.

Question 8

Normal Return

Answer 8

the actual return that the investment earns expressed in current dollars.

Question 9

Real Rate of Return

Answer 9

equals the nominal return minus the inflation rate, and it measures the increase in purchasing power provided by an investment.

Question 10

Required Return

Answer 10

the rate of return that fully compensates for an investment’s risk premium.

Question 11

Expected Inflation Premium

Answer 11

represents the average rate of inflation expected in the future.

Question 12

Risk Premium

Answer 12

varies depending on specific issue (the type of investment, its maturity, and its features) and issuer characteristics (industry and company factors).

Question 13

Holding Period

Answer 13

the period of time over which one wishes to measure the return on an investment.

Question 14

Realized Return

Answer 14

the portion of income received by the investor during the period.

Question 15

Paper Return

Answer 15

capital gain before the sale occurs.

Question 16

Holding Period Return

Answer 16

total return earned from holding an investment for a specified time. Equals Income during the period+capital gain/beginning investment value.

Question 17

Internal Rate of Return

Answer 17

determines the compound annual rate of return earned on investments longer than one year. (Yield)

Question 18

PV

Answer 18

Present Value, earliest value

Question 19

FV

Answer 19

Future value, latest value

Question 20

Reinvestment Rate

Answer 20

the rate of return you start with

Question 21

Fully Compounded Rate of Return

Answer 21

earning interest on interest

Question 22

Rate of Growth

Answer 22

the compound rate of change in the value of a stream of income, particularly dividends or earnings.

Question 23

Risk-return tradeoff

Answer 23

attempting to minimize risk for a given level of return or to maximize return for a given level of risk

Question 24

Business Risk

Answer 24

the degree of uncertainty associated with an investment’s earnings and the investment’s ability to pay the returns owed investors.

Question 25

Financial Risk

Answer 25

uncertainty surrounding a firm’s ability to meet its financial obligations because it has borrowed money.

Question 26

Purchasing Power Risk

Answer 26

the chance that unanticipated changes in price levels will adversely affect investment returns

Question 27

Interest Rate Risk

Answer 27

the chance that changes in interest rates will adversely affect a security’s value.

Question 28

Liquidity Risk

Answer 28

the risk of not being able to sell an investment quickly and at a reasonable price.

Question 29

Tax Risk

Answer 29

the chance that Congress will make unfavorable changes in tax laws

Question 30

Event Risk

Answer 30

occurs when something happens to a company that has a sudden and substantial impact on its financial condition.

Question 31

Market Risk

Answer 31

the risk that investment returns will decline because of market factors independent of the given instrument.

Question 32

Standard Deviation

Answer 32

measures the dispersion of returns around an asset’s average or expected return. (most common single indicator of an asset’s risk)

Question 33

Risk Indifferent

Answer 33

required return does not change as risk goes up.

Question 34

Risk Averse

Answer 34

Required return increases as risk increases

Question 35

Risk Seeking

Answer 35

Required return decreases for an increase in risk.