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4. Present Value and the Time Value of Money Measuring and Managing Risk The Value of Diversification The Relationship Between Risk and Return and the Security Market Line Tools of Finance The Financial System > Tools of Finance Free to share, print, make copies and changes. Get yours at www.boundless.com www.boundless.com/economics/textbooks/boundless-economics-textbook/the-financial-system-29/tools-of-finance-122/

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6. Key terms asset clas A group of economic resources sharing similar characteristics, such as riskiness and return. capital asset pricing model Used to determine the required rate of return of an asset taking into account an asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk). non-systematic risk Risk that is unique to a specific company; can be reduced through diversification. present value The value of an asset in today's dollars after adjusting for an increase in the asset values as a result of interest earned during the period. prospectus A document, distributed to prospective members, investors, buyers, or participants, which describes an institution (such as a university), a publication, or a business and what it has to offer. risk premium The minimum amount of money by which the expected return on a risky asset must exceed the known return on a risk-free asset security market line A line representing the relationship between expected return and systematic risk; thus a graphical representation of the capital asset pricing model. systematic risk The risk associated with an asset that is correlated with the risk of asset markets generally, often measured as its beta. time horizon A fixed point of time in the future where certain processes will be evaluated or assumed to end. time value of money The principle that a certain currency amount of money today has a different buying power (value) than the same currency amount of money in the future. Free to share, print, make copies and changes. Get yours at www.boundless.com The Financial System

7. Money Assuming a 5% interest rate, $100 invested today will be worth $105 in one year ($100 multiplied by 1.05). Conversely, $100 received one year from now is only worth $95.24 today ($100 divided by 1.05), assuming a 5% interest rate. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikimedia. CC BY-SA http://upload.wikimedia.org/wikipedia/en/f/fa/Stacks_of_money.jpg View on Boundless.comCC BY-SAhttp://upload.wikimedia.org/wikipedia/en/f/fa/Stacks_of_money.jpgView on Boundless.com The Financial System

8. Security market line The security market line depicts the the return on a security relative to its own risk. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikimedia. CC BY-SA http://upload.wikimedia.org/wikipedia/en/f/f3/SML-chart.png View on Boundless.comCC BY-SAhttp://upload.wikimedia.org/wikipedia/en/f/f3/SML-chart.pngView on Boundless.com The Financial System

9. Return expectations are based on risk analysis In finance and economics, as depicted in the graph above of the capital asset pricing model, risk is evaluated to set the boundary for acceptable return. Free to share, print, make copies and changes. Get yours at www.boundless.com Wikimedia. CC BY-SA http://upload.wikimedia.org/wikipedia/en/d/d9/SecMktLine.png View on Boundless.comCC BY-SAhttp://upload.wikimedia.org/wikipedia/en/d/d9/SecMktLine.pngView on Boundless.com The Financial System

10. Attribution Wikipedia. "Present value." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Present_valueCC BY-SA 3.0http://en.wikipedia.org/wiki/Present_value Wikipedia. "time value of money." CC BY-SA 3.0 http://en.wikipedia.org/wiki/time%20value%20of%20moneyCC BY-SA 3.0http://en.wikipedia.org/wiki/time%20value%20of%20money Wikipedia. "Time value of money." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Time_value_of_moneyCC BY-SA 3.0http://en.wikipedia.org/wiki/Time_value_of_money Wiktionary. "time horizon." CC BY-SA 3.0 http://en.wiktionary.org/wiki/time_horizonCC BY-SA 3.0http://en.wiktionary.org/wiki/time_horizon Wikipedia. "risk premium." CC BY-SA 3.0 http://en.wikipedia.org/wiki/risk%20premiumCC BY-SA 3.0http://en.wikipedia.org/wiki/risk%20premium Wikipedia. "Risk premium." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Risk_premiumCC BY-SA 3.0http://en.wikipedia.org/wiki/Risk_premium Wikipedia. "asset clas." CC BY-SA 3.0 http://en.wikipedia.org/wiki/asset%20clasCC BY-SA 3.0http://en.wikipedia.org/wiki/asset%20clas Wikipedia. "risk premium." CC BY-SA 3.0 http://en.wikipedia.org/wiki/risk%20premiumCC BY-SA 3.0http://en.wikipedia.org/wiki/risk%20premium Wiktionary. "prospectus." CC BY-SA 3.0 http://en.wiktionary.org/wiki/prospectusCC BY-SA 3.0http://en.wiktionary.org/wiki/prospectus Wikipedia. "Systematic risk." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Systematic_riskCC BY-SA 3.0http://en.wikipedia.org/wiki/Systematic_risk Wikipedia. "Diversification (finance)." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Diversification_(finance)CC BY-SA 3.0http://en.wikipedia.org/wiki/Diversification_(finance) Wiktionary. "security market line." CC BY-SA 3.0 http://en.wiktionary.org/wiki/security_market_lineCC BY-SA 3.0http://en.wiktionary.org/wiki/security_market_line Wiktionary. "systematic risk." CC BY-SA 3.0 http://en.wiktionary.org/wiki/systematic_riskCC BY-SA 3.0http://en.wiktionary.org/wiki/systematic_risk Wikipedia. "capital asset pricing model." CC BY-SA 3.0 http://en.wikipedia.org/wiki/capital%20asset%20pricing%20modelCC BY-SA 3.0http://en.wikipedia.org/wiki/capital%20asset%20pricing%20model Wikipedia. "non-systematic risk." CC BY-SA 3.0 http://en.wikipedia.org/wiki/non-systematic%20riskCC BY-SA 3.0http://en.wikipedia.org/wiki/non-systematic%20risk Wikipedia. "Capital asset pricing model." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Capital_asset_pricing_modelCC BY-SA 3.0http://en.wikipedia.org/wiki/Capital_asset_pricing_model Wikipedia. "Security market line." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Security_market_lineCC BY-SA 3.0http://en.wikipedia.org/wiki/Security_market_line Free to share, print, make copies and changes. Get yours at www.boundless.com The Financial System