Chapter 1 Definitions Flashcards
Define liquidity
Ease at which an asset or an investment contract can be converted into cash
without affecting the asset’s price. Assets which are readily convertible into cash are said to exhibit
high (good) liquidity. Cash is by definition the ultimate liquid asset.
Define marketability
Marketability is a measure of the ability of an asset to be bought and sold. If there is an active market-
place for the asset, then it has good marketability. Marketability is similar to liquidity, except that
liquidity implies that the value of the asset is preserved, whereas marketability simply indicates it can be bought and sold easily
What makes an investment more attractive in terms of marketability
Investors will be attracted to investments which come in a range of different forms and have marketable features. Because the investment can be bought or sold more easily
Define volatility
Volatility is defined as the relative rate at which the price of an asset moves up and down. If the price
of an asset moves up and down rapidly over short time periods, it has high volatility. If the price almost
never changes, it has low volatility.
What assets are traditionally most volatile and why is volatility of concern to investors
Equities are most volatile, the performance of a company cannot be predicted in advance and can vary quite a lot depending
on the state of the economy. Its of most concern to investors who may need to disinvest their investment in the near future.
Explain diversification
Diversification is an investment strategy designed to reduce exposure to risk by combining a variety
of investments, such as stocks, bonds, and property, which are unlikely to all move in price in the same
direction. The goal of diversification is to reduce the risk in a portfolio.
Name two types of diversification
Sector and stock diversification
Why assets classes offer inflation protection
Returns on equities and property have been strongly correlated with inflation: sort of protection. Cash and deposit funds, though extremely stable they do not correlate well with inflation.
What two taxes can be charged on investment gains
Income tax and capital gains tax
What does income refer to for the purpose of income tax
Income refers to any form of regular payment an investor receives in relation to an asset she has
bought or is entitled to. The government will take a percentage of an investor’s income payment in the form of a tax.
What does capital gain mean for the purpose of tax
In finance a capital gain is a profit that is realized from the sale of an asset that was previously
purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds,
and property. Capital gains is only charged once when the asset is disposed of. Tax is charged only on a capital gain. Sometimes an investor may be allowed to offset the capital loss but otherwise we just don’t charge anything
What is bond stripping
Some banks will allow the interest payments and the redemption amounts
to be bought and sold individually. This
Describe the risk of gilts
Gilts issued by governments of developed countries are the most secure type of investment outside
of cash. There is little or no risk that such governments would default on either the regular interest
payments or the capital repayment. For governments in less stable countries this risk would be more
significant.
What are 4 reasons a return on a government bond may not be known for certainty
Incoem and redemption gaisn are subject to taxes which rates can change
Investors may decide to reinvest the interest payments
Investor can choose to sell the bond before redemption
Real return over and above inflation is unknown
Define a government bill
A government bill is a short-dated security issued by governments to fund their short-term spending
requirements. Terms are typically between 3 and 12 months. Each bill will have a par value and the
investor buys the bill at a discount and redeems the bill at par.
