CFA Level 1 Exam 3 || With Questions & Answers (Rated A+) – With Financial Ratios
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Module
CFA - Chartered Financial Analyst
Institution
CFA - Chartered Financial Analyst
CFA Level 1 Exam 3 || With Questions & Answers (Rated A+) – With Financial Ratios
CFA Level 1 Exam 3 || With Questions & Answers (Rated A+) – With Financial Ratios
The principle of time value of money - ANSWER - The notion that a given sum of money is more valuable the sooner it is received...
, CFA Level 1 Exam 3 || With Questions
& Answers (Rated A+) – With Financial
Ratios
The principle of time value of money - ANSWER - The notion that a given sum of
money is more valuable the sooner it is received, due to its capacity to earn interest.
The Five Components of Interest Rates - ANSWER - 1. Real Risk-Free Rate 2.
Expected Inflation 3. Default-Risk Premium 4. Liquidity Premium 5. Maturity
Premium
Real Risk-Free Rate - ANSWER - This assumes no risk or uncertainty, simply
reflecting differences in timing: the preference to spend now/pay back later versus
lend now/collect later.
Expected Inflation - ANSWER - The market expects aggregate prices to rise, and the
currency's purchasing power is reduced by a rate known as the inflation rate.
Inflation makes real dollars less valuable in the future and is factored into
determining the nominal interest rate (from the economics material: nominal rate =
real rate + inflation rate).
Default-Risk Premium - ANSWER - What is the chance that the borrower won't make
payments on time, or will be unable to pay what is owed? This component will be
high or low depending on the creditworthiness of the person or entity involved.
Liquidity Premium - ANSWER - Some investments are highly liquid, meaning they
are easily exchanged for cash (U.S. Treasury debt, for example). Other securities
are less liquid, and there may be a certain loss expected if it's an issue that trades
infrequently. Holding other factors equal, a less liquid security must compensate the
holder by offering a higher interest rate.
Maturity Premium - ANSWER - All else being equal, a bond obligation will be more
sensitive to interest rate fluctuations the longer to maturity it is.
The stated annual rate - ANSWER - (or quoted rate) is the interest rate on an
investment if an institution were to pay interest only once a year.
In practice, institutions compound interest more frequently, either ... - ANSWER
- ...quarterly, monthly, daily and even continuously.
The effective annual yield... - ANSWER - ...represents the actual rate of return,
reflecting all of the compounding periods during the year.
Effective annual rate (EAR) - ANSWER - = (1 + Periodic interest rate)^m - 1
(Where: m = number of compounding periods in one year, and periodic interest rate
= (stated interest rate) / m)
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