Untitled Quiz

The interest rate for a specific time interval at a particular point in time.

An agreed-upon interest rate for a future time period, starting at a future date.

The extra compensation for accepting uncertainty about future bond prices, when the forward rate is greater than the expected short rate.

A theory where the forward rate equals the market's expectation for the future short rate, and assumes liquidity premiums are zero.

A graph that plots the yield on bonds of varying maturities. It typically shows the relationship between the maturity and yield of a bond.

Investors prefer short-term bonds to long-term bonds because they avoid liquidity risk.

The risk that an asset cannot be readily sold at a fair market value when needed.

A yield curve where longer maturities have higher yields than shorter maturities.

Bond duration measures a bond's sensitivity to interest rate changes. It indicates how much the bond price will change for a given change in interest rates.

The duration of a zero-coupon bond is equal to its time to maturity.

Lower coupon rates lead to higher bond durations, all else equal.

Generally, bond duration increases with time to maturity, though at a decreasing rate.

Lower yields to maturity generally lead to higher bond durations, all else equal.

The duration of a perpetuity is calculated as (1 + y) / y, where y is the yield to maturity.

Bond duration is a key measure of interest rate risk. It quantifies the potential price change of a bond due to interest rate fluctuations.

Duration is an approximation of price sensitivity to yield changes, best for small yield changes. Bonds with higher convexity deviate more from linearity in price-yield relationships, requiring a more accurate measure than duration for larger yield changes.

The weighted average of the durations of its component zero-coupon bonds.

A strategy where one purchases bonds with maturities and payments that match future liabilities to minimize interest rate risk.

The risk that interest rates will decline, forcing reinvestment of coupon payments at lower rates, reducing future returns.

Higher coupon rates result in shorter durations, because more cash flows are received earlier, making the bond less sensitive to interest rate changes.

Duration measures how much the market value of a bond changes in response to a change in interest rates.

The portfolio's composition is held constant over a single investment period, meaning there is no rebalancing.

The returns on investments are assumed to follow a normal distribution, allowing probability calculations to be made.

The strategy of investing in various assets to reduce risk and potential losses. By spreading investments across different asset classes, the overall portfolio becomes less volatile.

The extent to which the prices or returns of two assets move together. A high positive correlation means they move in the same direction, while a low or negative correlation means they move independently or in opposite directions.

Assets that tend to move independently of each other, minimizing the overall portfolio risk. When one asset performs poorly, the other might perform well, providing some protection.

A curve that represents the set of portfolios with the lowest possible risk for each level of expected return. Every point on the MVF contains the optimal portfolio for its corresponding return level.

A portfolio for an investor that offers the most favorable risk-return trade-off. It is a point on the MVF, providing the lowest possible risk for the desired level of return.

A measure of an asset's volatility relative to the market. It indicates how much an asset's price is likely to change in response to changes in the market.

An asset's price is expected to move in the same direction as the market. A beta greater than 1 indicates the asset is more volatile than the market.

An asset's price is expected to move in the opposite direction to the market. A beta less than 0 indicates the asset is negatively correlated with the market.

The risk that is inherent in the overall market and cannot be diversified away. It's also known as market risk or non-diversifiable risk.

The risk that is specific to a particular asset or company. This risk can be diversified away by investing in a portfolio of assets.

A model that describes the relationship between risk and expected return for an asset. It states that the expected return of an asset is equal to the risk-free rate plus a risk premium that is proportional to the asset's beta.

The total risk of an asset can be decomposed into two components: systematic risk and unsystematic risk. Systematic risk is the risk that cannot be diversified, while unsystematic risk can be diversified.

The Capital Asset Pricing Model (CAPM) assumes all rational investors hold diversified portfolios, eliminating unsystematic risk. Therefore, the CAPM only prices systematic risk. Investors are not compensated for taking on unsystematic risk because it can be diversified away.

The CAPM states that the expected return of an asset is determined by its beta (β), which measures the asset's systematic risk relative to the market.

The CAPM suggests a passive investment strategy, meaning investors should hold a well-diversified portfolio, such as the market portfolio, instead of trying to beat the market.

The SML is a graphical representation of the relationship between the expected return of an asset and its beta (systematic risk). The SML slopes upwards because higher risk is rewarded with higher expected returns.

An asset's beta (β) determines its position on the SML. An asset with a beta of 1 has the same risk as the market, while a beta of 0.5 means half the risk, and a beta of 2 means double the risk.

Individual assets typically plot below the Capital Allocation Line (CAL) because the CAL represents efficient portfolios where unsystematic risk is diversified away. Thus, the total risk of an asset on the CAL is equal to its systematic risk.

Both the SML and the Capital Market Line (CML) start at the risk-free rate (rf), but the CML considers total risk (σ) while the SML only considers systematic risk (β). The CML only includes efficient assets/portfolios.

Only systematic risk earns a reward under the CAPM. Unsystematic risk can be diversified away and does not contribute to expected returns.