Systematic risk - Also known as non-diversifiable risk, attributable to market factors that
affect all firms; can't be eliminated through diversification
Unsystematic risk - Also known as diversifiable risk, attributable to firm-specific, random
causes; can be eliminated through diversificat...
Systematic risk - Also known as non-diversifiable risk, attributable to market factors that
affect all firms; can't be eliminated through diversification
Unsystematic risk - Also known as diversifiable risk, attributable to firm-specific, random
causes; can be eliminated through diversification.
Beta - Relative measure of non-diversifiable risk. An index of the degree of movement
of an asset's return in response to a change in the market return
CAPM(Capital Asset Pricing Model) - Describes the relationship btw the required return
and the non-diversifiable risk of the firm as measured by beta.
CAPM(2) - The basic theory that links risk and return for all assets
SML(Security Market Line) - Depiction of the CAPM as a graph that reflects the required
return in the marketplace for each level of non-diversifiable risk
Risk Averse - The attitude toward risk where investors would require an increased
return as compensation for an increase in risk
Annuity - A stream of equal periodic cash flows over a specified time period. These
cash flows can be inflows or outflows
Annuity Due - An annuity for which the cash flow occurs at the beginning of each period
Bond - Long-term debt instrument used by business and government to raise large
sums of money, generally from a diverse group of lenders
Preferred Stock - A special form of ownership having a fixed periodic dividend that must
be paid prior to payment of any dividends to common stockholders
Common Stock - The purest and most basic form of corporate ownership
Gordon Model - Also known as the constant growth model that is widely cited in
dividend valuation
Diversification - Reduces risk, combines to adds assets that have a low correlation with
each other
Risk - A measure of uncertainty surrounding the return that an investment will earn or,
more formally, the variability of returns associated with a given asset
, C.V.(Coefficient of variation) - A measure of relative dispersion that is useful in
comparing the risks of assets with differing expected returns
Payback Method - How long it takes to recover an investment
NPV - The best and correct method. Most theoretical method
Advantages of NPV - Answer is in dollars, shows the change in the value of the firm,
reinvestment rate assumption for the cash flows is the discount rate
Disadvantage of NPV - Some managers don't understand the answer or misinterpret the
answer
Formula for NPV - Cost of capital adjusted by the risk of the cash flows -initial
investment from PV total
IRR - The discount rate that makes the present value of the cash inflows equal the initial
investment(similar to bond yields)
Rule of IRR - If IRR is > required return(cost of capital) than accept the project
Advantages of IRR - Answer is is a yield of rate of return, managers like an answer as a
rate of return
Disadvantages of IRR - If the cf can't be reinvested at the IRR rate, the IRR calculation
is incorrect
IRR(fill in the blank) - With the mutually exclusive projects, the __ may give the wrong
project selection.(conflict with the NPV due to the reinvestment rate assumption)
Timing differences and scale effect - The 2 conditions for IRR are the _ _ and _ _
PI (Profitability Index) - the present value of cash flows divided by the initial
investment(its a ratio)
MIRR(Modified IRR) - Use the required rate of returns to adjust the expected cash flows
Rule of MIRR - iF MIRR is equal to or larger than Cost of Capital accept the project
Advantages of MIRR - Cf are reinvested at the cost of capital(better assumption), single
solution when there are embedded negative cfs, MIRR is superior to IRR
Disadvantages of MIRR - Conflict can still occur with NPV, if there is a scale effect, NPV
is superior
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