Rates and Returns

Question 1

Equilibrium interest rate is…

Answer 1

The required rate of return for a particular investment

Question 2

Interest rates are also known as Discount rates because…

Answer 2

If an individual is borrowing funds at 10% interest, then the individual should discount payments to be made in the future to get their equivalent current value.

Question 3

Interest Rate can be viewed as Opportunity Cost because…

Answer 3

If market rate of return on 1-year security is 5%, earning this additional 5% is the opportunity that we lost by consuming that money instead of saving.

Question 4

Real risk-free rate of interest

Answer 4

Theoretical rate on a single-period loan that contains no expectation of inflation and zero probability of default

Question 5

Real rate of return refers to…

Answer 5

Increase in the purchasing power of investors after adjusting for inflation as the expected future inflation is not zero

Question 6

U.S T-bills are…

Answer 6

Risk-free rates but not real rates of returns. (Nominal risk-free rates)

Question 7

Nominal risk-free rates contain…

Answer 7

Inflation premium.

(1+ nominal risk free rate) = (1+real risk free rate)(1+ expected inflation rate)

or

nominal risk-free rate ≈ real risk-free rate + expected inflation rate

Question 8

Default Risk

Answer 8

Borrower will not make promised returns on a timely manner

Question 9

Liquidity Risk

Answer 9

Risk of receiving less than fair value for an investment if it must be sold quickly for cash

Question 10

Maturity risk

Answer 10

Longer-term bonds’ prices are more volatile than short-term bonds leading to more maturity risk and require a maturity risk premium

Question 11

Risk premium will be added to the nominal risk-free rate to adjust for…

Answer 11

greater default risk, less liquidity, and longer maturity relative to a liquid, short-term, default risk-free rate such as that on T-bills.

Question 12

nominal rate of interest =

Answer 12

real risk-free rate + inflation premium + default risk premium + liquidity risk premium + maturity risk premium

Question 13

Holding Period return =

Answer 13

(end-of-period value/beginning-of-period value) -1

Question 14

HPR of a stock that pays a dividend =

Answer 14

(Pt+DIVt)/Po -1

Question 15

HPR for 3 years

Answer 15

(1+HPR year1)(1+HPR year2)(1+HPR year3)-1

Return over multiple years is typically stated as Annualized return rather than HPR

Question 16

Arithmetic Mean Return

Answer 16

Simple average of series of periodic returns.

Question 17

Which has the statistical property of being an unbiased estimator of the true mean of underlying distributing returns.

Answer 17

Arithmetic Mean Return

Question 18

Geometric Mean Return is a

Answer 18

Compound rate of returns over multiple periods and is always ≤ AM. The difference increases as the dispersion of the observations increases

Question 19

Harmonic Mean used for

Answer 19

average cost of shares purchased over time

Question 20

The relationship between AM, GM and HM can be stated as

Answer 20

AM X HM =(GM)^2

Question 21

Cost Averaging is a

Answer 21

practice of purchasing same amount of mutual funds every month or week

Question 22

If the variables in observations are different then the relationship between AM, GM, and HM is…

Answer 22

HM<GM<AM