Chapter 4

Deflation

A period of generally declining prices.

Inflation

A period of generally rising prices.

Risk Premium

A return premium that reflects the issue and issuer characteristics associated with a given investment vehicle.

Paper Return

A return that has been achieved but not yet realized by an investor during a given period.

Coefficient of Variation, CV

A statistic used to measuer the relative dispersion of an asset's returns; it is useful in comparing the risk of assets with differing average or expected returns.

Standard Deviation, s

A statistic used to measure the dispersion (variation) of returns around an asset's average or expected return.

Annuity

A stream of equal cash flows that occur at equal intervals over time.

Mixed Stream

A stream of returns that, unlike an annuity, exhibits no special pattern.

Ordinary Annuity

An annuity for which the cash flows occur at the end of each period.

Satisfactory Investment

An investment whose present value of benefits (discounted at teh appropriate rate) equals or exceeds the present value of its costs.

Realized Return

Current income actually received by an investor during a given period.

Risk-indifferent

Describes an investor who does not require a change in return as compensation for greater risk.

Risk-averse

Describes an investor who requires greater return in exchange for greater risk.

Risk-seeking

Describes an investor who will except lower return in exchange for greater risk.

Continuous Compounding

Interest calculation in which interest is compounded over the smallest possible interval of time.

Compound Interest

Interest paid not only on the initial deposit but also on any interest accumulated from one period to the next.

Simple Interest

Interest paid only on the initial deposit for the amount of time it is held.

Market Risk

Risk of decline in investment returns because of market factors independent of the given investment.

Interest

The "rent" paid by a borrower for use of the lenders money.

True Rate of Interest (return)

The actual rate of interest earned.

Future Value

The amount to which a current deposit will grow over a period of time when it is placed in an account paying compound interest.

Discount Rate

The annual rate of return that could be earned currently on a similar investment; used when finding present value; also called opportunity cost.

Expected Inflation Premium

The average rate of inflation expected in the future.

Tax Risk

The chance that Congress will make unfavorable changes in tax laws, driving down the after-tax returns and market values of certain investments.

Interest Rate Risk

The chance that changes in interest rates will adversely affect a security's value.

Purchasing Power Risk

The chance that changing price levels (inflation or deflation) will adversely affect investment returns.

Risk

The chance that the actual return from an investment may differ from what is expected.

Rate of Growth

The compound annual rate of change in the value of a stream of income.

Yield (interest rate of return)

The compound annual rate of return earned by a long-term investment; the discount rate that produces a present value of the investment's benefits that just equals its cost.

Business Risk

The degree of uncertainty associated with an investment's earnings and the investment's ability to pay the returns owed investors.

Financial Risk

The degree of uncertainty of payment attributable to the mix of debt and equity used to finance a business; the larger the proportion of debt financing, the greater the risk.

Time Value of Money

The fact that as long as an opportunity exists to earn interest, the value of money is affected by the point in time when the money is received.

Return

The level of profit from an investment-that is, the reward for investing.

Holding Period

The period of time over which one wishes to measure the return on an investment vehicle.

Required Return

The rate of return an investor must earn on an investment to be fully compensated for its risk.

Reinvestment Rate

The rate of return earned on interest or other income received from an investment over its investment horizon.

Risk-free Rate

The rate of return that can be earned on a risk-free investment; the sum of the real rate of return and the expected inflation premium.

Real Rate of Return

The rate of return that could be earned in a perfect world where all outcomes are known and certain--where there was no risk.

Fully Compounded Rate of Return

The rate of return that includes interest earned on interest.

Risk-return Tradeoff

The relationship between risk and return, in which investments with more risk should provide higher returns, and vice versa.

Expected Return

The return an ivestor thinks an investment will earn in the future.

Liquidity Risk

The risk of not being able to liquidate an investmenet conveniently and at a reasonable price.

Total Return

The sum of current income and the capital gain (or loss) earned on an investment over a specified period of time.

Holding Period Return (HPR)

The total return earned from holding an investment for a specified holding period (usually 1 year or less).

Present Value

The value today of a sum to be received at some future date; the inverse of future value.

Current Income

Usually cash or near-cash that is periodically received as a result of owning and investment.