number of periods per year (3) Period rate = APR / number of
periods per year (4) NOTE THAT YOU SHOULD NEVER DIVIDE
THE EFFECTIVE RATE BY THE NUMBER OF PERIODS PER YEAR-
it will not give you the period rate.
Effective Annual Rate (EAR)
Implied rate of interest / discount rate:
We can re-arrange the
basic PV and FV equations and then solve for the implied
interest rate i
Different types of loans:
(1) Pure discount loans (2) Interest
only loans (3) Loans with fixed principal payments (4)
Amortised loans
Pure discount loans:
(1) No interest; principal paid to
maturity; issued at discount which means their purchase price
is less than principal (2) T bills are excellent examples of pure
discount loans. The principal amount is repaid at some future
date, without any periodic interest payments
Interest only loan:
(1) Interest paid throughout the load
period; principal paid at maturity (2) Consider a 3 year,
interest only loan with a 7% interest rate, principal amount is
$10000. (3) Year 1 and 2: $700. Year 3: $10700 (4) this cash
flow stream is similar to the cash flows on corporate bonds
Loan with fixed principal payment:
(1) Interest and fixed
amount of principal paid throughout the load period (2)
Consider a $50000, 10 year loan at 8% interest. The loan
agreement requires the firm to pay $5000 in principal each
year plus interest of that year.
Amortised loans:
Each equal payment covers the interest
expense plus reduces principal
Lecture 4: Risk & Return- Part 1
Different kinds of stocks/investments:
(1) Standard & Poor’s
500 (S&P 500) (2) Small stocks (3) World portfolio (4)
Corporate bonds (5) Treasury bills (T bills)
Investment returns
measure the financial results of an
investment. Returns can be historical or prospective
(anticipated).
Dollar terms
: amount received – amount invested
Percentage terms
: (amount received – amount invested) /
amount invested
When an investor buys a stock or a bond, their return
comes
in 2 forms: (1) Any dividend or interest payment (income)
received (2) A capital gain or a capital loss (due to change in
price)
Dividend yield
= dividend / initial share price
Capital gain yield
= capital gain / initial share price
To convert from nominal rate to real rate of return:
1 + real return = (1 + nominal return) / (1 + inflation rate)
Approximation: real return = nominal return – expected
inflation
Expected returns
are returns that take into account
uncertainties that are present in different scenarios.

If using historical data of an asset to estimate average return,
can just find the arithmetic average
:
We benchmark the expected returns to the
required rate of
returns
.
Rate of returns
depends on the risk of the investment. High
risk = high rate of returns.
Risk
is the uncertainty associate with future possible
outcomes. Investment risk refers to the potential for the
investment return to fluctuate- go up or down- in value from
year to year.

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- Spring '11
- tohmunheng
- Capital Asset Pricing Model, Financial Markets, Investing, Modern portfolio theory