IRR Flashcards
(40 cards)
investment
current commitment of money or allocation of funds by
owning an asset to accumulate wealth over the long term or generating income from the
investment
putting assets to their most
productive use to earn a return
inflation
rate of increase in prices over a period of time and a decrease of the purchasing value of money
demand pull
demand from consumers pulls prices up.
➢ there is an increase in demand for goods and services but not enough of a corresponding
increase in supply.
➢ businesses can’t scale their production quickly enough to meet the demand. As a result, prices
increase
cost push
supply costs (production costs) force prices higher.
➢ Monopolies can also contribute to cost-push inflation because a monopoly controls the entire
supply of a good or service.
tangible / real assets
not as liquid:
Residential property
➢ Commercial property
➢ Commodities (raw material): grains,
gold, platinum, diamonds
➢ Collectible items: coins, stamps
safest form of investment hence lower return initially
financial/ intangible assets/securities
highly liquid
Bonds : Government and corporate
➢ Fixed deposit
➢ Money market accounts
➢ Shares
➢ Unit trusts
highly volatile/high risk
bonds
These are financial securities issued by companies, governments, or municipalities in order to borrow
from the public (e.g., government and corporate bonds).
▪ Bond issuers have an obligation to pay bondholders (a) fixed interest amounts (or coupons) annually
or semi-annually; & (b) the principal sum on maturity
safer (less risky) than shares (interest & capital sum guarantee) but return on bonds is less than the return on share
types of bonds
Plain Vanilla Bonds /Straight bonds
➢ Coupon payments are fixed for the life of the bond. The entire original principal is paid at maturity
▪ Zero–coupon Bonds
➢ There are no coupon payments and single payment at maturity
➢ Interest paid to the bondholder is the difference between the principal amount paid current
amount received at maturity
▪ Convertible Bonds
➢ Converted into ordinary shares at some predetermined ratio at the discretion of the bondholder
▪ Callable Bonds
➢ The company issuing a bond may include a special provision that allows an issuer to redeem the
bond at a present price
▪ Perpetual Bonds
➢ A perpetual bond is a bond with no maturity date. It is not redeemable but pays a steady stream of
interest forever.
▪ Treasury bonds
➢ Government securities
fixed deposits
fixed lump-sum amount is deposited with a bank at a fixed rate and for a fixed per. Advantages: Returns tend to be higher than the more flexible savings accounts. Also, you
benefit if interest rates in the market decrease.
➢ Disadvantages: Lack of access to the money makes them illiquid. Also, you lose if interest rates in the market increase
Money Market Accounts
Bank deposit accounts pay higher interest rates than savings accounts, but require higher minimum
deposits.
safer than shares, less return
ordinary shares
Confers ownership in a company and shareholders are entitled to: voting rights (at the AGM) and
dividends (when declared).
➢ Advantages: In the long-term, they outperform bonds and money market instruments,
easy to buy and sell (being listed), information is easily available (annual
reports and share prices), hundreds of firms to choose from.
➢ Disadvantages: The risk is higher than that of bonds and money market instruments.
Dividends are not guaranteed and you could lose the original investme
pref shares
Regarded as fixed income securities because the dividend is fixe
unit trusts/collective investment scheme
investment product that allows many investors to pool their money into a single fund.
▪ The fund money is then invested in assets like shares, bonds, and money market instruments.
➢ Advantages: They allow ordinary people to invest in shares that would normally be out of their
financial reach had their monies not been pooled with that of other investors.
They reduce investment risk through diversification.
They are flexible. One can invest either a lump sum or small monthly amounts.
They are liquid – one can sell part or all the investment at any time.
➢ Disadvantages: Returns are earned in the long-term rather than the short-term. Like any
investment, the market may collapse and investors may lose their investmen
return on investment
Total holding period =capital gain+ income
types of return
Actual return: return based on the known returns produced by the investment in the past.
➢ Expected return: weighted average of the possible returns from an investme
➢ Required return: minimum return that an investor requires from an investment to compensate
them for risk associated with an investment
actual return
return based on the known returns produced by the investment in the past.
Total holding period =capital gain+ income
Capital appreciation (capital gains yield/ return)𝑅CA– Amount arising from price changes of an
asset over the investment: (P1-P0)/P0
Income (divided yield/ return) R1 – periodic amounts the investor receives from the asset (
dividends or interest received D/P0
expected return
weighted average of the possible returns from an investme
no dividend therefore
RT = (P1-P0)/P0
expected return: %chance x RT
add together
required return
minimum return that an investor requires from an investment to compensate
them for risk associated with an investment
CAPM formula
Required rate = risk free rate + Beta(market risk premimum)
market rusk premium= Return on market - risk free
Beta interpretation
measure of non-diversifiable risk
= 1.0: the asset has the same systematic risk as the market.
> 1.0: the asset has more systematic risk than the market.
< 1.0: the asset has less systematic risk than the market.
= 0: the asset is risk-free. No systematic risk
measures of risk
variance and the standard deviat
variance
Measures the difference between actual outcome and expected outcome.
➢ The greater the difference between possible actual and expected outcomes, the greater the risk
because there is more uncertainty
standard deviation
square root of the variance. The statistical notation for standard deviation is 𝜎.
▪ Remember that Variance measures risks in terms of percentage squared
calculate risk
Given historical data (prices or returns), calculating the variance and standard deviation involves
the following steps:
- First, use the actual returns to calculate the (arithmetic) average or mean return. Divide the
total of all the annual returns by no. of years.
- Second, calculate the differences (or deviations) between each year’s actual return and the
average return (expected return).
- Third, calculate the squared deviations and sum them up.
- Fourth, the historical variance is = the sum of squared deviations divided by the number of
observations minus one.
- The standard deviation is equal to the square root of the variance. It is a measure of the
dispersion of possible outcomes (returns).
- The greater the standard deviation, the greater the uncertainty and, therefore, the greater the
ris
deviation intervals
1: 68%
1.645: 90%
1.960: 95%
2.575: 99%
