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Flashcards in BPM: Financial Risk Management Deck (23):
1

Risk Averse

Managers that anticipate greater return for greater risk

2

Risk Indifferent

describes a manager who is neutral with regard to the return associated with a particular investment. Typically, the amount of a risk free rate of return associated with an investment of a given amount compared to a higher return associated with higher risk is viewed as having equal value.

3

Risk seeking behavior

behavior describes managers who seek reduced return for higher risk

4

Liquidity risk

desire to sell their security, but cannot do so in a timely manner or when material price concessions have to be made to do so.

5

Interest rate risk

is the fluctuation in the value of a "financial asset" when interest rates change

6

Purchasing power risk

risk that price levels will change and affect asset values (mostly real estate).

7

Market Risk

The exposure of a security or firm to fluctuations in value as a result of operating within an economy is referred to as market risk.

8

Credit Risk

Affects borrowers. If Risk increases then Interest rate will increase

9

Default Risk

Affects lenders. may not repay the principal or interest due

10

Stated Interest Rate (Definition)

represents the rate of interest charged before any adjustment for compounding or market factors. Shown in the agreement of indebtedness

11

Computation Of Return

compensates investors and creditors for assumed risk

12

Effective Interest Rate

Actual finance charge associated with a borrowing after reducing loan proceeds for charges and fees related to a loan origination

13

Computation of Effective Interest Rates
(Look at Page 40 for example)

Effective Interest Rates are computed by dividing the amount of interest paid based on the loan agreement by the net proceeds received.

14

Annual Percentage Rate (APR)
(Look at Page 40 for example)

Effective Periodic Rate X # of compounding periods

15

Effective Annual Interest Rate

=[1+(i/p)]p-1

i= Stated interest rate
p = compounding periods per year

16

Compound Interest

Interest paid only on the original amount of principal without regard to compounding

17

Compound Interest Formula

FVn= P(1+i)n
P= Original Price
i= Interest rate
n= Number of periods

18

Maturity Risk Premium

the compensation that investors demand for exposure to interest rate risk over time

19

Purchasing Power Risk or Inflation Premium

compensation investors require to bear the risk that price levels will change and affect asset values or the purchasing power of invested dollars

20

Liquidity Risk Premium

The additional compensation demanded by lenders

21

Default Risk Premium

additional compensation demanded by lenders for bearing the risk that the issuer of the security will fail to pay interest and/or principal due on a timely basis

22

Subjective Probability

based on an individuals belief about the likelihood that a given event will occur

23

Expected Value

is the weighted- average of the probable outcomes