Debt Risk

Most people are risk averse

Financial Risk

Investor is an individual – depends on the investment horizon

Amount of time until the investment proceeds are needed.

Difficult to define measure or translate into something usable for decision making

Both businesses and investors are subject to financial risk.

Investors bear the riskiness inherent in the business but it is modified by the contractual nature of the securities they hold.

NFP – risk for the business is split between the creditors and the implied stockholders.

Risk – a hazard, a peril, or exposure to loss or injury.

Unfavorable outcome.

* Financial risk – risk of losing money.

Treasury bills are short-term federal debt securities that are sold at a discount and return face value at maturity.

Risk free – 100 percent probability that the investment will earn the percent rate of return expected.

The financial risk is related to the probability of earning a return that is less than expected.

The greater the chance of low or negative returns the greater the amount of financial risk.

Risk Aversion

An individual who takes a sure amount and run are risk averse

An individual who is indifferent to alternatives is risk neutral

Gambler is a risk seeker

* Probability Distributions

The event that an event will occur – probability of occurrence

A result of a probability – probability distribution

If an individual buys stocks – return is in dividends and capital gains or losses (selling the stock for less than what paid for)

Expected and Realized Rates of Return

Concept of financial risk defined more precisely

Economic states

Expected rate of return – weighted average of the return distribution, the weights being the probabilities of occurrence.

Realized rate of return – rate of return that the investment produced as measured at termination.

Stand alone risk- riskiness of each investment under the assumption that it would be the business’s only asset.

Depends on the tightness of an...