Chapter 5

Question 1

Name the 4 fundamental factors determining interest rates

Answer 1

1- supply of funds for saving (households)
2- demand of funds from businesses (investments)
3- governments demand for funds ( fed)
4- expected rate of inflation

Question 2

What is Effective Annual Rate (EAR)?

Answer 2

% increase in funds investments over 1 year horizon
- compounded return
- used for T>1

Question 3

What is Annual Percentage Rate (APR)?

Answer 3

• annualising using simple interest
• not compounded
• used on short-term investments T<1

Question 4

What is variance a measure of?

Answer 4

• variance/s.d is a measure of volatility of returns
  -I.e. higher variance = higher risk

Question 5

What is the sharpe ratio?

Answer 5

• reward-to-volatility ratio
• risk premium/SD of excess returns
• higher sharpe ratio = better investment

Question 6

Describe skewness

Answer 6

Measure of the asymmetry of a distribution
- +ve skewness- majority of distribution on the right
- good for portfolio
- opposite is true for -ve skew

Question 7

Describe kurtosis

Answer 7

Measure of whether the data are heavily-tailed or light tailed relative to normal distribution
- fat tails: realise much more extreme values