Financial Assets and Prices

Question 1

What do the buyers and sellers do to affect the equilibrium?

Answer 1

are driven to offer higher or lower prices and quantities that move the economy toward equilibrium

Question 2

What is the economic equilibrium?

Answer 2

condition where market forces are balanced

Question 3

What does it mean to be insolvent?
and what the IRS states with liabilities and assets…

Answer 3

the financial state in which a person or entity is no longer able to pay the bills or other obligations.
The IRS states that a person is insolvent when the total liabilities exceed total assets.

Question 4

What’s Arbitrage?

Answer 4

Arbitrage is the ability to make profits from discrepancies between prices of
different assets but without bearing any price risk

Question 5

Whats a nominal interest rate?

Answer 5

is the premium paid by a borrower to have the use of lender’s funds for some
period of time

Question 6

Whats the formula for the nominal interest rate?

Answer 6

𝑖 = (𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑟𝑒𝑝𝑎𝑦𝑚𝑒𝑛𝑡 – 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐿𝑜𝑎𝑛)/𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐿𝑜𝑎𝑛

Question 7

Whats the real interest rate?

Answer 7

is the premium paid by a borrower to have the use of lender’s funds for
some period of time, in terms of goods and services
nominal adjusted for price level changes

Question 8

Whats the real interest rate formula?

Answer 8

𝑟 = (𝑅𝑒𝑎𝑙 𝑟𝑒𝑝𝑎𝑦𝑚𝑒𝑛𝑡 – 𝑅𝑒𝑎𝑙 𝐿𝑜𝑎𝑛)/𝑅𝑒𝑎𝑙 𝐿𝑜𝑎𝑛

Question 9

Whats the fisher equation?

Answer 9

r = i - π^e

Question 10

The actual formula for the real interest rate?

Answer 10

real loan

Question 11

What the Fisher equation says that these two contracts should be equivalent to…

Answer 11

(1 + i) = (1 + r) × (1 + π).

Question 12

What are the pay periods for a Simple Loan?

Answer 12

pay interest and principal at end

Question 13

What are the pay periods for a Fixed Payment

Answer 13

pay interest and principal every period

Question 14

What are the pay periods for a Coupon Bond?

Answer 14

interest every period and principal at end

Question 15

What are the pay periods for a Discount Bond?

Answer 15

pay principal at end

Question 16

What is present value?

Answer 16

Today’s value of a payment (or series of payments) to be received in the
future if the current interest rate is 𝑖

Question 17

What is the present value formula?

Answer 17

𝑃𝑉 = 𝐹𝑃/(1 + 𝑖)

Question 18

What is the formula for present value when considering more than 1 pay period?

Answer 18

PV = sum of: FP(t)
——
(1+i)^t

Question 19

Whats the definition of yield to maturity?

Answer 19

the interest rate that equates the present value of payments received from a
credit market instrument with its value (price) today

Question 20

Whats the formula for yield of maturity?

Answer 20

PV = sum of: FP(t)
——
(1+y)^t

Question 21

Whats the formula for the rate of return?

Answer 21

The payments to the owner of a security (interest or yield) plus the change
in the securities value expressed as a fraction of the purchase price

Question 22

How’s change of value calculated?

Answer 22

capital gain/loss

Question 23

Whats the current yield?

Answer 23

This tells you the percentage investors would earn on a bond if they bought it today and held it for a year, factoring in the market price and the coupon rate on the bond.

Question 24

Whats the Yield on a discount basis?
not too important but what’s it commonly used for…

Answer 24

A discount yield is a way of calculating a bond’s return when it is sold at a discount to its face value, expressed as a percentage
Discount yield is commonly used to calculate the yield on municipal notes, commercial paper and treasury bills sold at a discount.

Question 25

Whats the bond market?

Answer 25

It is the collective name given to all trades and issues of debt securities

Question 26

Why do governments issue bonds?

Answer 26

Governments issue bonds to raise capital to pay debts or fund infrastructural improvements

Question 27

Why do publicly traded companies issue bonds?

Answer 27

Publicly traded companies issue bonds to finance business expansion projects or maintain ongoing operations.

Question 28

What is the loanable funds market?

Answer 28

The market for loanable funds is a way of representing all of the potential savers and all of the potential borrowers in an economy

Question 29

draw the loanable funds market?

Answer 29

...

Question 30

What is liquidity preference?

Answer 30

Liquidity preference theory argues that people prefer to keep assets in a liquid form such as cash rather than in less liquid assets like bonds, stocks, or real estate. The upshot is that investors expect a greater premium for taking on a longer-term loss of liquidity.

Question 31

What is the aim of the liquidity preference theory?

Answer 31

It aims to explain how interest rates are determined.

Question 32

Why do bonds with same maturity date have different interest rates? important!!!

Answer 32

credit risk, issuer reputation, and market conditions. The interest rate on a bond is influenced by the creditworthiness of the issuer; higher-risk issuers offer higher interest rates to attract investors

Question 33

Whats credit risk?

Answer 33

Credit risk is the possibility of a loss happening due to a borrower's failure to repay a loan or to satisfy contractual obligations

Question 34

Why do bonds that are identical in all respects except maturity date have different interest rates? important!!!

Answer 34

Bonds "with the same maturity" will have different interest rates because of three factors: default risk, liquidity, and tax considerations

Question 35

Whats risk premium?

Answer 35

the investment return an asset is expected to yield in excess of the risk-free rate of return

Question 36

What is Immunization?

Answer 36

Immunization is a risk-mitigation strategy that matches asset and liability duration so portfolio values are protected against interest rate changes.

Question 37

What does it mean to hedge?

Answer 37

An investment that is made with the intention of reducing the risk of adverse price movements in an asset.

Question 38

What does convexity mean?

Answer 38

Convexity is used to measure a portfolio's exposure to market risk.

Question 39

Active and passive strategies...

Question 40

What is a liability?

Answer 40

Liabilities are debts or obligations a person or company owes to someone else

Question 41

What is an asset?

Answer 41

anything you own that adds financial value

Question 42

What is a weighted average?

Answer 42

A weighted average is a calculation that assigns varying degrees of importance to the numbers in a particular data set