Net Present Value of an Investment Project
[vsw id=”lYpi92G13U4″ source=”youtube” width=”611″ height=”344″ autoplay=”no”] The Net present value (NPV) of a project refers to the present value of all cash inflows minus the present value of all cash outflows, evaluated at a given discount rate. The difference between…
Effective Annual Rate of Interest (EAR)
[vsw id=”qk19_k31K-4″ source=”youtube” width=”611″ height=”344″ autoplay=”no”] The effective annual rate of interest (EAR) refers to the rate of return earned by an investor in a year, taking the effects of compounding into account. Remember, compounding is the process by which…
Present and Future Values
Future Values The Future Value (FV) of a Single Sum of Cash Flow The Future Value (FV) of a single sum of money is the future amount of money invested today at a given interest rate (r) for a specified…
Portfolio of Risk-free and Risky Assets
By combining a portfolio of risky assets with a risk-free asset, we can improve the return-risk characteristics of the portfolio and realize a better trade-off. This combination is called the capital allocation line (CAL). The proportion of allocation to risky…
Capital Allocation Line (CAL) and Capital Market Line (CML)
We form a capital allocation line when we combine a risky asset portfolio with a risk-free asset. This represents the allocation between risk-free and risky assets based on investor risk preferences. The capital market line is a special case of…
Systematic and Non-systematic Risks
Systematic risk is inherent in the overall market and cannot be avoided. Non-systematic risk is limited to a particular asset class or security and can be avoided through appropriate portfolio diversification. Systematic Risk When you invest in a market, you face…
Return Generating Models
A return-generating model can provide investors with an estimate of the return of a particular security given certain input parameters. The most general form of a return-generating model is a multi-factor model. In its simplest form, the multi-factor model is…
Beta Explained
Beta is a measure of systematic risk. Statistically, it depends on the degree of correlation between a security and the market. Calculating Beta We begin with the single index model using realized returns constructed as follows: $$ R_i – R_f…
Capital Asset Pricing Model (CAPM)
The Capital Asset Pricing Model (CAPM) provides a linear relationship between the expected return for an asset and the beta. The Security Market Line (SML) represents CAPM on a graph. As opposed to the Capital Market Line (CML), where the…
