Overview of the Financial System

The ease and speed with which an asset can be converted into cash without significant loss in value.

The total resources owned by an individual, including all assets.

The degree of uncertainty associated with the return on an asset.

The percentage change in quantity demanded of an asset divided by the percentage change in wealth.

An asset for which the quantity demanded grows less proportionally than wealth, meaning the amount held relative to wealth falls as wealth grows.

The interest rate that makes the present value of all future cash flows from a debt instrument equal to its current market price.

The value today of a future cash flow, taking into account the time value of money.

The formula used to calculate the present value of a single future cash flow by discounting it back to the present using a discount rate.

The formula used to calculate the present value of a series of future cash flows by discounting each flow back to the present and summing them up.

A simple formula used to calculate the future value of an investment, taking into account simple interest.

The annual rate of return an investor can expect to receive on a bond if they hold it until maturity.

The yearly coupon payment divided by the current market price of the bond. It's a quick approximation of the YTM, especially when the bond is trading near its par value.

Represents the return on a discount bond (a bond priced below its face value) calculated based on the difference between the face value and the purchase price, taking into account the time to maturity.

The rate of return achieved by an investor who holds an investment over a specific period. It includes both the income received (like coupon payments) and any appreciation or depreciation in the value of the investment.

The return expressed as a percentage of the initial investment. It's a standardized way to compare different returns.

A model that uses multiple factors to explain the expected return of an asset, going beyond just market risk.

The idea that investors cannot make riskless profits in efficient markets. If an asset is mispriced, investors will exploit the difference, bringing it back to equilibrium.

The relationship between an asset's expected return and the various risk factors is assumed to be linear. In other words, as a risk factor increases, the expected return also changes proportionally.

The sensitivities, or factor loadings, of an asset to each specific risk factor. These coefficients show how much the expected return of an asset is expected to change for a one-unit change in the risk factor.

Any economic variables or influences that can affect the expected return of an asset. These can include things like inflation, interest rates, or GDP growth.

The percentage change in the price of a bond resulting from a 1% change in interest rates.

A measure of the sensitivity of a bond's price to changes in interest rates. A higher duration means a bond is more sensitive to rate changes.

The formula that calculates the duration of a bond, taking into account the timing and value of future cash flows.

A bond that pays no interest payments (coupons) and only pays the face value at maturity.

The value of a zero-coupon bond today, calculated by discounting the future face value at the current interest rate.

The relationship between the duration of a bond and its sensitivity to interest rate changes.

The rate of return on an investment in a bond, expressed as a percentage.

The process of calculating the present value of future cash flows, considering the time value of money.

A bond's face value, or the amount that will be paid back to the bondholder at maturity.

The remaining time until a bond matures and the principal is paid back.

A model that explains the relationship between the expected return of an asset and its risk. It assumes that investors are rational and seek to maximize returns for a given level of risk.

The risk that cannot be diversified away, usually driven by factors that impact all assets in the market. Examples include changes in interest rates, economic growth, or inflation.

The risk that can be reduced or eliminated by holding a diversified portfolio. It's specific to individual companies or investments.

The risk-free rate is the return an investor could earn on a risk-free investment, like a government bond. It represents the minimum return required to compensate for the time value of money.

The additional return an investor expects to earn for taking on the risk of investing in a particular security compared to the market. It's calculated as beta multiplied by the market risk premium.

A measure of an asset's volatility relative to the market. It indicates how much an asset's price will move in response to market movements.

A theoretical portfolio that includes all assets in the market, representing the perfect diversification across all possible investment opportunities.