Efective Annual Rate EAR Actual rate after taking into consideration any

# Efective annual rate ear actual rate after taking

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Efective Annual Rate EAR Actual rate after taking into consideration any compounding that may occur during the year. Need to ensure that interest rate and time period matches 1 + APR m ¿ ¿ EAR = ¿ Implied Discount Rate i =( FV PV ) 1 / n 1 For # of periods, 1 + r t = ln ( FV PV )/ ln ¿¿ Diferent types of loans 1) Pure Discount Loans: Payment of principal and interest rate at maturity 2) Interest only Loans: Interest paid annually but principal at maturity 3) Loan with fixed principal payment: Fixed principal portion and interest varies throughout loan period 4) Amortised Loan: Equal payment per period, include principal+interest Chapter 4 and 5: Risk and Return Diferent types of portfolios:S&P 500(Standard and Poor), Small stocks, World Portfolio, Corporate Bonds, Treasury Bills Investment returns measure the financial results of an investment. Returns may be historical or prospective Dollar terms: Amount received – Amount invested Percentage terms: Amount received – Amount invested Amount invested Totaldollar return = ¿ income + Capital ga Percentage Return : Dividend yield and capital gain yield Dividend yield = Dividend InitialSHare Price Capital gain yield = CapitalGain Initial share price The impact of inflation: Real VS Nominal Nominal return: Actual \$ received versus actual \$ given up Real rate of return : How much more you will be able to buy with your money at the end of the year. Taken inflation into account. Fisher Equation: Convert nominal rate to real rate 1 + r = 1 + N 1 + : OR Common approximation Realreturn = Nomialreturn Expected infla Expected Returns ^ r = i = 1 n r i p i Arithmetic Average Return ´ r = t = 1 T r t T Risk : The uncertainty associated with future possible outcomes Measure variability in investment returns via the Standard Deviation o = i = 1 n ( r i ^ r ) P i SD measures total risk, larger SD, high probability that actual returns far from expected. SD measures dispersion around expected value. Stand-Alone Risk: Risk an investor would face if he only held one asset. Using historical data to estimate the SD Estimated o = t = 1 n ( r t r avg ) 2 n 1 Coeficient of Variation: Standardized measure of dispersion about the expected value, that shows the risk per unit of return. CV = Standard Deviation Expeted rateof return CV = Standard Deviation Mean Lower CV indicates less relative variability or lower risk per unit Risk, return and Financial Markets • Greater the potential reward, greater the risk  Risk- return trade of • Low risk, low potential returns. High risk, high potential returns • Financial markets allow companies, govt and individuals to increase utility by matching borrower (Better access to capital to invest in productive assets) to savers (Ability to invest in financial assets) • Risk Aversion: Assumes investors dislike risk and require higher rates of return to encourage them to hold riskier securities • Risk Premium: Return over and above the risk-free rate • Risk free rate is the long term government bond rate r=Possible return p=Probability of

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• Spring '11
• tohmunheng
• Investing