Finance definitions

The exercise was created 2019-10-17 by arvidwest. Question count: 30.




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  • Beta Change in the excess return of a security given a 1% change in the excess return of the market portfolio
  • Risk-free investment An investment where the return is known with absolute certainty and there is no risk of default
  • Market, Efficient, Tangent Portfolio Where CML is tangent to efficient frontier of market
  • Security Market Line (SML) The linear relationship between a stock’s beta and its expected return
  • Capital Market Line (CML) Tangent line from risk-free rate that goes through the market portfolio (in relationship between expected return and volatility)
  • CAPM Allows us to identify the efficient portfolio of risky assets without knowing expected return of each security
  • Homemade Leverage When investors use leverage in own portfolios to adjust leverage choice made by firm
  • Perfect Capital Markets 1 Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows
  • Perfect Capital Markets 2 There are no taxes, transaction costs or issuance costs associated with security trading
  • Perfect Capital Markets 3 A firm’s financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them
  • Common (Systematic) Risk Risk that is perfectly correlated and that affects all securities and will not be diversified
  • Independent (Unsystematic) Risk Risk that is uncorrelated and that affects a particular security, due to firm-specific news
  • Market Portfolio Contains only systematic risk. Volatility of the portfolio can’t be reduced without lowering expected return
  • Nominal interest rate The rates quoted by financial institutions and used for discounting or compounding cash flows
  • Real interest rate The rate of growth of your purchasing power, after adjusting for inflation
  • Valuation Triad Model Links the firm’s future cash flows, cost of capital and share price. Information about two of these variables, a valuation model allows us to estimate the third variable
  • Conservation of Value Principle for Financial Markets With perfect capital markets, financial transactions neither add nor destroy value, but instead represent a repackaging of risk (and therefore return)
  • Maturity Date Final repayment date of face value and last coupon payment
  • Term The time remaining until the repayment date
  • Face Value (FV) Notional amount used to compute the interest payments
  • Coupon Rate Determines the amount of each coupon payment, expressed as an APR of Face Value
  • Zero-Coupon Bond A bond with no coupon payments
  • Tradeoff Theory in terms of capital structure A firm picks capital structure through tradeoff of benefits of tax shield from debt, against cost of financial distress
  • Put-Call Parity Two different ways to construct portfolio insurance - Purchase the stock and a put, or Purchase a bond and a call
  • Law of One Price If equivalent investment opportunities trade simultaneously in different competitive markets, then they must trade for the same price in both markets
  • Opportunity Cost The value a resource could have provided in its best alternative use
  • Project Externalities Indirect effects of the project that may affect the profits of other business activities of the firm
  • Sunk Costs Costs paid regardless of the decision whether or not the investment is undertaken
  • Break-Even Analysis The break-even level of an input is the level that causes the NPV of the investment to equal zero
  • Sensitivity Analysis How the NPV varies with a change in one of the assumptions, holding the other assumptions constant

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