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What does the APT formula consider when estimating the expected return of a financial asset?
What does the APT formula consider when estimating the expected return of a financial asset?
APT is based on the principle that arbitrage opportunities should exist in efficient markets.
APT is based on the principle that arbitrage opportunities should exist in efficient markets.
False
What does β represent in the APT formula?
What does β represent in the APT formula?
Sensitivities of the asset to the respective risk factors
The APT formula includes the risk-free rate, which is often represented by the return on __________.
The APT formula includes the risk-free rate, which is often represented by the return on __________.
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Match the following factors with their descriptions:
Match the following factors with their descriptions:
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What does i represent in the equation iR = i − π^e^?
What does i represent in the equation iR = i − π^e^?
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The wealth elasticity of demand for a luxury asset is equal to 1.
The wealth elasticity of demand for a luxury asset is equal to 1.
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What factor measures how much the quantity demanded of an asset changes in response to a change in wealth?
What factor measures how much the quantity demanded of an asset changes in response to a change in wealth?
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An asset that people hold regardless of their wealth is considered a __________.
An asset that people hold regardless of their wealth is considered a __________.
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Match the following assets with their classifications:
Match the following assets with their classifications:
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What is the interest rate of a simple loan of $100 with interest payments totaling $10?
What is the interest rate of a simple loan of $100 with interest payments totaling $10?
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The formula for calculating Future Value (FV) is the same as the formula for Present Value (PV).
The formula for calculating Future Value (FV) is the same as the formula for Present Value (PV).
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How is the Present Value (PV) calculated for a single cash flow?
How is the Present Value (PV) calculated for a single cash flow?
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The interest rate that equates the present value of payments received from a debt instrument with its value today is called ___.
The interest rate that equates the present value of payments received from a debt instrument with its value today is called ___.
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Match the following financial terms with their definitions:
Match the following financial terms with their definitions:
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What does a diversified portfolio help to eliminate?
What does a diversified portfolio help to eliminate?
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CAPM ignores taxes and transaction costs for simplicity.
CAPM ignores taxes and transaction costs for simplicity.
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What is the risk-free return in CAPM?
What is the risk-free return in CAPM?
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The expected return of a security is directly proportional to its _____ in CAPM.
The expected return of a security is directly proportional to its _____ in CAPM.
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Match the following components of CAPM with their definitions:
Match the following components of CAPM with their definitions:
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What is a key application of CAPM in corporate finance?
What is a key application of CAPM in corporate finance?
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CAPM considers multiple sources of systematic risk.
CAPM considers multiple sources of systematic risk.
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Name one limitation of CAPM.
Name one limitation of CAPM.
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Which formula represents the Yield to Maturity (YTM)?
Which formula represents the Yield to Maturity (YTM)?
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The current yield equals the coupon rate when the bond price is below par.
The current yield equals the coupon rate when the bond price is below par.
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What does 'C' represent in the context of bond valuation?
What does 'C' represent in the context of bond valuation?
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The formula for current yield is given by $i_{C} = \frac{C}{P_{b}}$, where $P_{b}$ is the _____ of the bond.
The formula for current yield is given by $i_{C} = \frac{C}{P_{b}}$, where $P_{b}$ is the _____ of the bond.
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Match the following terms with their definitions:
Match the following terms with their definitions:
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What will be the present value of a $1000 zero-coupon bond after one year if the interest rate is 20%?
What will be the present value of a $1000 zero-coupon bond after one year if the interest rate is 20%?
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An increase in interest rates will result in a decrease in the price of a zero-coupon bond.
An increase in interest rates will result in a decrease in the price of a zero-coupon bond.
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What is the formula to calculate the rate of capital gain (g) on a bond?
What is the formula to calculate the rate of capital gain (g) on a bond?
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The duration (D) of a bond is calculated using the formula involving cash payments (CP), interest rate (i), and years to maturity (N). D is expressed as the sum of _____.
The duration (D) of a bond is calculated using the formula involving cash payments (CP), interest rate (i), and years to maturity (N). D is expressed as the sum of _____.
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Match the following years to their corresponding present value of cash payments for a zero-coupon bond with a 10% interest rate.
Match the following years to their corresponding present value of cash payments for a zero-coupon bond with a 10% interest rate.
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What is the capital gain rate (g) for a zero-coupon bond if its price falls from $385.54 to $193.81?
What is the capital gain rate (g) for a zero-coupon bond if its price falls from $385.54 to $193.81?
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The duration of a bond increases if the interest rate decreases.
The duration of a bond increases if the interest rate decreases.
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If a bond has a duration of 6.75850, what does this indicate regarding its sensitivity to interest rate changes?
If a bond has a duration of 6.75850, what does this indicate regarding its sensitivity to interest rate changes?
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As per the capital gain calculation, if the initial price (P_t) is $385.54 and the price next year (P_t+1) is $193.81, then g equals ____.
As per the capital gain calculation, if the initial price (P_t) is $385.54 and the price next year (P_t+1) is $193.81, then g equals ____.
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What cash payment is anticipated from a $1000 ten-year coupon bond at the end of each year if the coupon rate is 10%?
What cash payment is anticipated from a $1000 ten-year coupon bond at the end of each year if the coupon rate is 10%?
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Study Notes
Overview of the Financial System
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Securities (Financial Instruments): Claims on a borrower's future income or assets. They are assets for the buyer and liabilities for the seller.
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Methods of Raising Funds:
- Debt Instruments: a contractual agreement to pay fixed dollar amounts at regular intervals until a maturity date.
- Short-term: maturity less than one year.
- Long-term: maturity over ten years.
- Intermediate-term: maturity between 1 and 10 years.
- Equities: claims to a share in a business' net income and assets.
- If you own 1 share of a company's 100 shares, you are entitled to 1% of the firm's net income and assets.
- Periodic payments (dividends) are made to shareholders.
- No maturity date.
- Considered long-term securities.
- Equity holders are residual claimants, meaning they are paid after all debt holders.
- Debt Instruments: a contractual agreement to pay fixed dollar amounts at regular intervals until a maturity date.
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Primary Markets: New security issues are sold to initial buyers by the issuing company or government agency.
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Secondary Markets: Previously issued securities are resold. Examples include stock exchanges (New York and American) and exchanges for commodities.
Securities (Financial Instruments)
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Brokers: Match buyers and sellers of securities at stated prices.
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Dealers: Link buyers and sellers of securities, acting as a market maker.
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Purpose of Secondary Markets:
- Increase liquidity of financial instruments.
- Determine securities' prices in primary markets.
Underwriting Securities
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Investment banks: Guarantee a price for a corporation's securities and then sell them to the public.
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Exchanges: Central locations where buyers and sellers conduct trades of securities (e.g., NYSE, American Stock Exchange).
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Over-the-counter (OTC) markets: Securities traded between dealers at different locations. Examples: The US government bond market.
Money Market
- Financial instruments with a maturity of less than one year.
- Usually more widely traded than longer-term securities.
- Considered more liquid and less volatile.
Capital Market
- Markeplaces for longer-term debt and equity instruments.
- Often held by financial intermediaries like insurance companies and pension funds.
Money Market Instruments:
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US Treasury Bills: Short-term debt instruments issued by the US government to finance budget deficits.
- No interest payments, but a set payoff amount at maturity.
Negotiable Bank Certificates of Deposit (CDs)
- Debt instrument sold by banks to depositors, paying annual interest and the original purchase price at maturity.
- Negotiable: can be sold to other parties.
- Payable on demand before maturity without penalty.
Banker's Acceptances
- Bank drafts guaranteed by banks, committing to payment at a future date.
- Used in international trade.
Commercial Paper
- Short-term debt instruments issued by large banks and well-known corporations.
Repurchase Agreements (Repos)
- Short-term loans, usually less than two weeks, where Treasury bills or other securities serve as collateral.
Federal Funds
- Overnight loans between banks of their deposits at the Federal Reserve.
- Not loans from the Federal Government or the Federal Reserve.
Federal Reserve System (FED)
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Setting Reserve Requirements: Fraction of transaction deposits that banks must keep in accounts with the FED.
- Regulates the books of banks under supervision.
- Imposes restrictions on assets they can hold.
Regulations Overview
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Government Regulations: The government mandates rules for financial intermediaries to protect the public and regulate financial systems.
- Who can operate: Regulated by state banking commissions and the Office of the Comptroller of the Currency.
- Bookkeeping: Standards for financial records and periodic inspections.
- Restricted activities: Limit the types of activities financial institutions can perform to safeguard public interests.
Federal Funds Rate:
- Closely watched barometer that indicates credit conditions and monetary policy stance.
- High rates = tight credit, indicating potential strains for banks.
- Low rates = easier credit, for smoother financial operations.
Capital Market Instruments
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Stocks: Individual or corporate equity ownership; individual ownership and institutional ownership combined.
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Mortgages: Funds to individuals to purchase real estate, land, or other structures.
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Corporate Bonds: Long-term bonds with very strong credit ratings; corporations issue to raise capital.
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US Government Securities: Long-term debt instruments issued by the U.S. government; they are among the most traded and liquid securities in the U.S. capital market.
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US Government Agency Securities: Obligations from US Government agencies who finance projects and programs by issuing securities to fund their goals.
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Description
This quiz covers the fundamental aspects of the financial system, focusing on securities, methods of raising funds, and the characteristics of different financial instruments. It also delves into primary markets and the nature of equities versus debt instruments. Test your knowledge of key concepts in finance!
