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wheat, autos, real estate, computers, and machinery. Financial asset markets, on the other hand,
deal with stocks, bonds, notes, mortgages, derivatives, and other financial instruments.
Spot markets and futures markets are markets where assets are being bought or sold for on-thespot delivery (literally, within a few days) or for delivery at some future date, such as 6 months or a
year into the future.
Money markets are the markets for short-term, highly liquid debt securities, while capital markets
are the markets for corporate stocks and debt maturing more than a year in the future. The New York
Stock Exchange is an example of a capital market. When describing debt markets, short term
generally means less than 1 year, intermediate term means 1 to 5 years, and long term means
more than 5 years.
Mortgage markets deal with loans on residential, agricultural, commercial, and industrial real estate,
while consumer credit markets involve loans for autos, appliances, education, vacations, and so on.
are interested in all the ratios and that financial appearances must be kept up if the firm is to be
regarded highly by creditors and equity investors.
The par value is the nominal or face value of a stock or bond. The par value of a bond generally
represents the amount of money that the firm borrows and promises to repay at some future date.
The maturity date is the date when the bond's par value is repaid to the bondholder.
A call provision may be written into a bond contract, giving the issuer the right to redeem the
bonds under specific conditions prior to the normal maturity date.
A bond's coupon, or coupon payment, is the dollar amount of interest paid to each bondholder
on the interest payment dates.
Convertible bonds are securities that are convertible into shares of common stock, at a fixed
price, at the option of the bondholder.
Bond prices and interest rates are inversely related; that is, they tend to move in the opposite
direction from one another.
Stand-alone risk is only a part of total risk and pertains to the risk an investor takes by holding
only one asset.
Risk is the chance that some unfavorable event will occur.
Expected rate of return (^r) is the expected value of a probability distribution of expected
returns
Risk averse investor dislikes risk and requires a higher rate of return as an inducement to buy
riskier securities.
A risk premium is the difference between the rate of return on a risk-free asset and the expected
return on Stock i which has higher risk.
The market risk premium is the difference between the expected return on the market and the
risk-free rate.
CAPM is a model based upon the proposition that any stocks required rate of return is equal to
the risk free rate of return plus a risk premium reflecting only the risk remaining after
diversification.
Market risk is that part of a securitys total risk that cannot be eliminated by diversification. It is
measured by the beta coefficient.
Diversifiable risk is also known as company specific risk, that part of a securitys total risk
associated with random events not affecting the market as a whole.
The relevant risk of a stock is its contribution to the riskiness of a well-diversified portfolio.
The beta coefficient is a measure of a stocks market risk, or the extent to which the returns on a
given stock move with the stock market.
The security market line (SML) represents in a graphical form, the relationship between the risk
of an asset as measured by its beta and the required rates of return for individual securities.
If risk aversion increases, the slope of the SML will increase,
Investment return measures the financial results of an investment. They may be expressed in
either dollar terms or percentage terms.
The standard deviation is a measure of a securitys (or a portfolios) stand-alone risk. The larger
the standard deviation, the higher the probability that actual realized returns will fall far below the
expected return, and that losses rather than profits will be incurred.
Using either or CV as our stand-alone risk measure, the stand-alone risk of the portfolio is
significantly less than the stand-alone risk of the individual stocks.