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Risk–return Spectrum
The risk–return spectrum (also called the risk–return tradeoff or risk–reward) is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment. The more return sought, the more risk that must be undertaken. The progression There are various classes of possible investments, each with their own positions on the overall risk-return spectrum. The general progression is: money market, short-term debt; long-term debt; property; high-yield debt; equity. There is considerable overlap of the ranges for each investment class. All this can be visualised by plotting expected return on the vertical axis against risk (represented by standard deviation upon that expected return) on the horizontal axis. This line starts at the risk-free rate and rises as risk rises. The line will tend to be straight, and will be straight at economic equilibrium, equilibrium (see discussion below on risk–return spectrum#Domination, domination). ...
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Investment
Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broader viewpoint, an investment can be defined as "to tailor the pattern of expenditure and receipt of resources to optimise the desirable patterns of these flows". When expenditures and receipts are defined in terms of money, then the net monetary receipt in a time period is termed cash flow, while money received in a series of several time periods is termed cash flow stream. In finance, the purpose of investing is to generate a Return (finance), return on the invested asset. The return may consist of a capital gain (profit) or loss, realised if the investment is sold, unrealised capital appreciation (or depreciation) if yet unsold. It may also consist of periodic income such as dividends, interest, or rental income. The return may also inclu ...
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Credit Rating
A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government). It is the practice of predicting or forecasting the ability of a supposed debtor to pay back the debt or default. The credit rating represents an evaluation from a credit rating agency of the qualitative and quantitative information for the prospective debtor, including information provided by the prospective debtor and other non-public information obtained by the credit rating agency's analysts. Credit reporting (or credit score) is a subset of credit rating. It is a numeric evaluation of an ''individual's'' credit worthiness, which is done by a credit bureau or consumer credit reporting agency. Sovereign credit ratings A sovereign credit rating is the credit rating of a sovereign entity, such as a national government. The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors when looki ...
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Derivative (finance)
In finance, a derivative is a contract between a buyer and a seller. The derivative can take various forms, depending on the transaction, but every derivative has the following four elements: # an item (the "underlier") that can or must be bought or sold, # a future act which must occur (such as a sale or purchase of the underlier), # a price at which the future transaction must take place, and # a future date by which the act (such as a purchase or sale) must take place. A derivative's value depends on the performance of the underlier, which can be a commodity (for example, corn or oil), a financial instrument (e.g. a stock or a bond), price index, a price index, a currency, or an interest rate. Derivatives can be used to insure against price movements (Hedge (finance)#Etymology, hedging), increase exposure to price movements for speculation, or get access to otherwise hard-to-trade assets or markets. Most derivatives are price guarantees. But some are based on an event or p ...
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Debt
Debt is an obligation that requires one party, the debtor, to pay money Loan, borrowed or otherwise withheld from another party, the creditor. Debt may be owed by a sovereign state or country, local government, company, or an individual. Commercial debt is generally subject to contractual terms regarding the amount and timing of repayments of #Principal, principal and interest. Loans, bond (finance), bonds, notes, and Mortgage loan, mortgages are all types of debt. In financial accounting, debt is a type of financial transaction, as distinct from equity (finance), equity. The term can also be used metaphorically to cover morality, moral obligations and other interactions not based on a monetary value. For example, in Western cultures, a person who has been helped by a second person is sometimes said to owe a "debt of gratitude" to the second person. Etymology The English term "debt" was first used in the late 13th century and comes by way of Old French from the Latin verb ' ...
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Risk Premium
A risk premium is a measure of excess return that is required by an individual to compensate being subjected to an increased level of risk. It is used widely in finance and economics, the general definition being the expected risky Rate of return, return less the Risk-free interest rate, risk-free return, as demonstrated by the formula below. Risk \ premium = E(r) - r_f Where E(r) is the risky expected rate of return and r_f is the risk-free return. The inputs for each of these variables and the ultimate interpretation of the risk premium value differs depending on the application as explained in the following sections. Regardless of the application, the market premium can be volatile as both comprising variables can be impacted independent of each other by both cyclical and abrupt changes. This means that the market premium is dynamic in nature and ever-changing. Additionally, a general observation regardless of application is that the risk premium is larger during economic do ...
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Hedge (finance)
A hedge is an investment Position (finance), position intended to offset potential losses or gains that may be incurred by a companion investment. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance policy, insurance, forward contracts, swap (finance), swaps, option (finance), options, gambles, many types of Over-the-counter (finance), over-the-counter and Derivative (finance), derivative products, and futures contracts. Public futures markets were established in the 19th century to allow transparent, standardized, and efficient hedging of agricultural commodity prices; they have since expanded to include futures contracts for hedging the values of Energy derivative, energy, precious metals, foreign currency, and interest rate fluctuations. Etymology Hedging is the practice of taking a position in one market to offset and balance against the risk adopted by assuming a position in a contrary or opposing market o ...
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Leverage (finance)
In finance, leverage, also known as gearing, is any technique involving borrowing funds to buy an investment. Financial leverage is named after a lever in physics, which amplifies a small input force into a greater output force. Financial leverage uses borrowed money to augment the available capital, thus increasing the funds available for (perhaps risky) investment. If successful this may generate large amounts of profit. However, if unsuccessful, there is a risk of not being able to pay back the borrowed money. Normally, a lender will set a limit on how much risk it is prepared to take, and will set a limit on how much leverage it will permit. It would often require the acquired asset to be provided as collateral security for the loan. Leverage can arise in a number of situations. Securities like options and futures are effectively leveraged bets between parties where the principal is implicitly borrowed and lent at interest rates of very short treasury bills.Mock, E. J., R. ...
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Large-cap
Market capitalization, sometimes referred to as market cap, is the total value of a publicly traded company's outstanding common shares owned by stockholders. Market capitalization is equal to the market price per common share multiplied by the number of common shares outstanding. Description Market capitalization is sometimes used to rank the size of companies. It measures only the equity component of a company's capital structure, and does not reflect management's decision as to how much debt (or leverage) is used to finance the firm. A more comprehensive measure of a firm's size is enterprise value (EV), which gives effect to outstanding debt, preferred stock, and other factors. For insurance firms, a value called the embedded value (EV) has been used. It is also used in ranking the relative size of stock exchanges, being a measure of the sum of the market capitalizations of all companies listed on each stock exchange. The total capitalization of stock markets or econo ...
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Market Capitalization
Market capitalization, sometimes referred to as market cap, is the total value of a publicly traded company's outstanding common shares owned by stockholders. Market capitalization is equal to the market price per common share multiplied by the number of common shares outstanding. Description Market capitalization is sometimes used to rank the size of companies. It measures only the equity component of a company's capital structure, and does not reflect management's decision as to how much debt (or leverage) is used to finance the firm. A more comprehensive measure of a firm's size is enterprise value (EV), which gives effect to outstanding debt, preferred stock, and other factors. For insurance firms, a value called the embedded value (EV) has been used. It is also used in ranking the relative size of stock exchanges, being a measure of the sum of the market capitalizations of all companies listed on each stock exchange. The total capitalization of stock markets or eco ...
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Ownership Equity
In finance, equity is an ownership interest in property that may be subject to debts or other liabilities. Equity is measured for accounting purposes by subtracting liabilities from the value of the assets owned. For example, if someone owns a car worth $24,000 and owes $10,000 on the loan used to buy the car, the difference of $14,000 is equity. Equity can apply to a single asset, such as a car or house, or to an entire business. A business that needs to start up or expand its operations can sell its equity in order to raise cash that does not have to be repaid on a set schedule. When liabilities attached to an asset exceed its value, the difference is called a deficit and the asset is informally said to be "underwater" or "upside-down". In government finance or other non-profit settings, equity is known as "net position" or "net assets". Origins The term "equity" describes this type of ownership in English because it was regulated through the system of equity law that develo ...
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Junk Bonds
In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit events but offer higher yields than investment-grade bonds to compensate for the increased risk. As of 2024, high-yield bonds have a higher yield than U.S. Treasury securities. Default risk As indicated by their lower credit ratings, high-yield debt entails more risk to the investor compared to investment grade bonds. Investors require a greater yield to compensate them for investing in the riskier securities. In the case of high-yield bonds, the risk is largely that of default: the possibility that the issuer will be unable to make scheduled interest and principal payments in a timely manner.:208 The default rate in the high-yield sector of the U.S. bond market has averaged about 5% over the long term. During the liquidity crisis of 198 ...
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