- D076 UNIT 3 Finance Skills EXAMS GRADED A+

A company that produces soap, shampoo, lotion, and other personal care products has recently taken a hit due to a competitor's new product line. The company decides to reduce wages for its labor force to save money while the company focuses on building up its reputation again, but the company's labor force goes on strike to protest the pay cuts. What type of risk does the strike represent? - Idiosyncratic risk adaptive expectations - When the prices of goods and services go up, employees expect and even demand higher wages to maintain their standard of living. An increase in wages therefore reflects the increased prices of goods and services. Although there are many sources of inflation, we are going to mention three main sources: - increased demand for goods and services, rising costs, and adaptive expectations. An interest rate is determined by the market's supply and demand and is thus composed of the following: - Opportunity cost Risk Inflation annual percentage rate (APR) - The annual interest rate that is charged for borrowing money or that is earned through investment. annuity - a stream of cash flows of an equal amount paid every consecutive period annuity due - paid at the beginning of consecutive periods. An example may be taking out an auto loan Bonds with a rating of BBB and above are considered - investment-grade bonds Bonds with the ratings of BB or below are called - non-investment grade business cycle example - oversupply leads to declining margins, which impacts an entire industry for an extended period of time. Compounding - means finding a future value given a present value compounding interest - The interest on the principal plus the interest on earned interest. Total interest=PrincipalX(1+Interest rate)number of periods-Principal Compounding involves - finding the future value of a cash flow (or a set of cash flows) using a given discount or interest rate. Correlation - the way two variables move in relation to each other. For example, the returns on two stocks might be correlated if one always increases when the other increases and always decreases when the other decreases. When combining assets into a portfolio, we usually get some amount of risk reduction but not total risk elimination. The lower the correlation among the assets in the portfolio, the greater the risk reduction possibilities for the portfolio. cost of capital - The cost to a firm to use an investor's capital default risk - the probability of a loss resulting from a borrower's failure to repay a contractual obligation.This is a firm-specific risk and affects both the bonds and stocks of the firm. discount rate - The name for interest rate when used in time value of money calculations.You can find the future value or past value of today's dollars given. example, if you ask, "How much will I have in 10 years if I save $1,000 today in an account with an interest rate of 5%?" then 5% is the discount rate needed to find how much you will have in 10 years. discounting - finding a present value given a future value. Diversification - is the process of "spreading" your money over many different assets. The wisdom behind this is captured nicely in the saying, "Don't put all your eggs in one basket." Why would you not want all your eggs in a single basket? Or for these purposes, what is the advantage of spreading your wealth over more than one asset? The driving principle behind the common wisdom of this is correlation Diversification only decreases risk up to a certain point, - at which there is market risk that cannot be diversified away. expected return - to calculate a hypothesized or "best-guess" estimate of future prices or returns under different scenarios Firm-specific risk - (also called nonsystematic risk or idiosyncratic risk) can be defined as risk that results from factors at a particular firm or handful of firms. Firm-specific risk is the risk associated with what? - with problems that companies may face because of lawsuits, labor problems, or management decisions, among other factors. can be diversified away. firm's financial risk - depends on how much debt the firm has, which affects earnings and stock prices. Fisher Effect - An economic theory developed by Irving Fisher holding that the real interest rate is equivalent to the nominal interest rate minus the expected inflation rate. Five years ago, Ahmed decided he was going to save up to purchase a car with cash. The car he wants is priced at $15,000. He saved $245 a month in an account that gave him enough interest to have $15,000