Probability & Risk
A measure of uncertainty about the future payoff to an investment, assessed over some time horizon and relative to a benchmark.
What is Risk?
What is Spreading Risk?
A promise to pay the face value of the bond on a specific future date, with no coupon payments.
What is a Zero-Coupon Bond?
Formula to find a price of a perpetuity.
Price = (Yearly Coupon Payment)/(Interest Rate)
The probability that a borrower will not repay a loan (AKA credit risk.
What is Default Risk?
The expected return minus the risk-free rate of return
What is Risk Premium?
Risk affecting a small number of people (a specific firm or industry)
What is Idiosyncratic Risk?
Makes periodic interest payments and repays the principal at maturity.
What is a Coupon Bond?
The yield bondholders receive if they hold the bond to its maturity when the final principal payment is made.
What is Yield to Maturity?
The risk that the real value of the payment from owning a bond will be different from what was expected.
What is Inflation Risk?
The probability-weighted sum of possible value of an investment; also known as the mean or average.
What is Expected Value?
Economywide risk that affects everyone and cannot be diversified.
What is Systematic Risk?
Secretary of State that brought bonds to the U.S in 1789.
Who is Alexander Hamilton?
Yearly coupon payment divided by the price paid.
What is the Current Yield?
The risk that the interest rate will change, causing the price of a bond to change with it.
What is Interest Rate Risk.
An investment whose future value is known with certainty.
What is a Risk-Free Asset?
Splitting wealth among a variety of assets to reduce risk.
What is Diversification?
A promise to pay a fixed number of equal payments at regular intervals.
What is Fixed-Payment Loans?
The return from purchasing and selling a bond (applies to bonds sold before or at maturity)
What is Holding Period Return?
Three factors that shift bond supply.
What is (1) Changes in Government Borrowing (2) General Business Conditions and (3) Expected Inflation)?
The worst possible loss over a specific time horizon at a given probability; a measure of risk.
What is Value at Risk (VaR)?
Reducing overall risk by investing in two assets with opposing payoffs.
What is Hedging?
A coupon bond in which the issuer makes regular interest payments forever, never repaying the principal.
What is a Perpetuity or Consol?
The relationship between the price and the quantity of bonds that investors demand, all other things being equal.
What is Bond Demand Curve?
Six factors that shift bond demand.
What is (1) Wealth (2) Expected Inflation (3) Expected Return on Stocks and other Assets (4) Expected Interest Rates (5) Risk and (6) Liquidity of Bonds?