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Risk-free asset

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Definition of Risk-free asset

Risk-free Asset Image 1

Risk-free asset

An asset whose future return is known today with certainty.



Related Terms:

Riskless or risk-free asset

An asset whose future return is known today with certainty. The risk free asset is
commonly defined as short-term obligations of the U.S. government.


Acquisition of assets

A merger or consolidation in which an acquirer purchases the selling firm's assets.


Arbitrage-free option-pricing models

Yield curve option-pricing models.


Asset

Any possession that has value in an exchange.


Asset/equity ratio

The ratio of total assets to stockholder equity.



Asset/liability management

Also called surplus management, the task of managing funds of a financial
institution to accomplish the two goals of a financial institution:
1) to earn an adequate return on funds invested, and
2) to maintain a comfortable surplus of assets beyond liabilities.


Asset activity ratios

Ratios that measure how effectively the firm is managing its assets.


Risk-free Asset Image 2

Asset allocation decision

The decision regarding how an institution's funds should be distributed among the
major classes of assets in which it may invest.


Asset-backed security

A security that is collateralized by loans, leases, receivables, or installment contracts
on personal property, not real estate.


Asset-based financing

Methods of financing in which lenders and equity investors look principally to the
cash flow from a particular asset or set of assets for a return on, and the return of, their financing.


Asset classes

Categories of assets, such as stocks, bonds, real estate and foreign securities.


Asset-coverage test

A bond indenture restriction that permits additional borrowing on if the ratio of assets to
debt does not fall below a specified minimum.


Asset for asset swap

Creditors exchange the debt of one defaulting borrower for the debt of another
defaulting borrower.


Asset pricing model

A model for determining the required rate of return on an asset.


Asset substitution

A firm's investing in assets that are riskier than those that the debtholders expected.


Asset substitution problem

Arises when the stockholders substitute riskier assets for the firm's existing
assets and expropriate value from the debtholders.


Risk-free Asset Image 3

Asset swap

An interest rate swap used to alter the cash flow characteristics of an institution's assets so as to
provide a better match with its iabilities.


Asset turnover

The ratio of net sales to total assets.



Asset pricing model

A model, such as the Capital asset Pricing Model (CAPM), that determines the required
rate of return on a particular asset.


Assets

A firm's productive resources.


Assets requirements

A common element of a financial plan that describes projected capital spending and the
proposed uses of net working capital.


Bankruptcy risk

The risk that a firm will be unable to meet its debt obligations. Also referred to as default or insolvency risk.


Basis risk

The uncertainty about the basis at the time a hedge may be lifted. Hedging substitutes basis risk for
price risk.


Business risk

The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.


Call risk

The combination of cash flow uncertainty and reinvestment risk introduced by a call provision.


Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security
plus a risk premium.


Commercial risk

The risk that a foreign debtor will be unable to pay its debts because of business events,
such as bankruptcy.


Risk-free Asset Image 4

Company-specific risk

Related: Unsystematic risk



Completion risk

The risk that a project will not be brought into operation successfully.


Counterparty risk

The risk that the other party to an agreement will default. In an options contract, the risk
to the option buyer that the option writer will not buy or sell the underlying as agreed.
Country economic risk Developments in a national economy that can affect the outcome of an international
financial transaction.


Country financial risk

The ability of the national economy to generate enough foreign exchange to meet
payments of interest and principal on its foreign debt.


Country risk General

Level of political and economic uncertainty in a country affecting the value of loans or
investments in that country.


Credit risk

The risk that an issuer of debt securities or a borrower may default on his obligations, or that the
payment may not be made on a negotiable instrument. Related: Default risk


Cross-border risk

Refers to the volatility of returns on international investments caused by events associated
with a particular country as opposed to events associated solely with a particular economic or financial agent.


Currency risk

Related: Exchange rate risk


Currency risk sharing

An agreement by the parties to a transaction to share the currency risk associated with
the transaction. The arrangement involves a customized hedge contract embedded in the underlying
transaction.


Current assets

Value of cash, accounts receivable, inventories, marketable securities and other assets that
could be converted to cash in less than 1 year.


Default risk

Also referred to as credit risk (as gauged by commercial rating companies), the risk that an
issuer of a bond may be unable to make timely principal and interest payments.


Diversifiable risk

Related: unsystematic risk.


Dynamic asset allocation

An asset allocation strategy in which the asset mix is mechanistically shifted in
response to -changing market conditions, as in a portfolio insurance strategy, for example.


Economic risk

In project financing, the risk that the project's output will not be salable at a price that will
cover the project's operating and maintenance costs and its debt service requirements.


Equilibrium market price of risk

The slope of the capital market line (CML). Since the CML represents the
return offered to compensate for a perceived level of risk, each point on the line is a balanced market
condition, or equilibrium. The slope of the line determines the additional return needed to compensate for a
unit change in risk.


Event risk

The risk that the ability of an issuer to make interest and principal payments will change because
of rare, discontinuous, and very large, unanticipated changes in the market environment such as (1) a natural
or industrial accident or some regulatory change or (2) a takeover or corporate restructuring.


Exchange of assets

Acquisition of another company by purchase of its assets in exchange for cash or stock.


Exchange rate risk

Also called currency risk, the risk of an investment's value changing because of currency
exchange rates.


Exchange risk

The variability of a firm's value that results from unexpected exchange rate changes or the
extent to which the present value of a firm is expected to change as a result of a given currency's appreciation
or depreciation.


Fallout risk

A type of mortgage pipeline risk that is generally created when the terms of the loan to be
originated are set at the same time as the sale terms are set. The risk is that either of the two parties, borrower
or investor, fails to close and the loan "falls out" of the pipeline.


Financial assets

Claims on real assets.


Financial risk

The risk that the cash flow of an issuer will not be adequate to meet its financial obligations.
Also referred to as the additional risk that a firm's stockholder bears when the firm utilizes debt and equity.


Firm-specific risk

See:diversifiable risk or unsystematic risk.


Fixed asset

Long-lived property owned by a firm that is used by a firm in the production of its income.
Tangible fixed assets include real estate, plant, and equipment. Intangible fixed assets include patents,
trademarks, and customer recognition.


Fixed asset turnover ratio

The ratio of sales to fixed assets.


Flat price risk

Taking a position either long or short that does not involve spreading.


Force majeure risk

The risk that there will be an interruption of operations for a prolonged period after a
project finance project has been completed due to fire, flood, storm, or some other factor beyond the control
of the project's sponsors.


Foreign exchange risk

The risk that a long or short position in a foreign currency might have to be closed out
at a loss due to an adverse movement in the currency rates.


Free cash flows

Cash not required for operations or for reinvestment. Often defined as earnings before
interest (often obtained from operating income line on the income statement) less capital expenditures less the
change in working capital.


Free float

An exchange rate system characterized by the absence of government intervention. Also known as
clean float.


Free on board

Implies that distributive services like transport and handling performed on goods up to the
customs frontier of the economy from which the goods are classed as merchandise.


Free reserves

Excess reserves minus member bank borrowings at the Fed.


Free rider

A follower who avoids the cost and expense of finding the best course of action and by simply
mimicking the behavior of a leader who made these investments.


Funding risk

Related: interest rate risk


Geographic risk

risk that arises when an issuer has policies concentrated within certain geographic areas,
such as the risk of damage from a hurricane or an earthquake.


Herstatt risk

The risk of loss in foreign exchange trading that one party will deliver foreign exchange but the counterparty financial institution will fail to deliver its end of the contract. It is also referred to as settlement risk.


Idiosyncratic Risk

Unsystematic risk or risk that is uncorrelated to the overall market risk. In other words,
the risk that is firm specific and can be diversified through holding a portfolio of stocks.


Inflation risk

Also called purchasing-power risk, the risk that changes in the real return the investor will
realize after adjusting for inflation will be negative.


Insolvency risk

The risk that a firm will be unable to satisfy its debts. Also known as bankruptcy risk.


Intangible asset

A legal claim to some future benefit, typically a claim to future cash. Goodwill, intellectual
property, patents, copyrights, and trademarks are examples of intangible assets.


Interest rate risk

The risk that a security's value changes due to a change in interest rates. For example, a
bond's price drops as interest rates rise. For a depository institution, also called funding risk, the risk that
spread income will suffer because of a change in interest rates.


Liquid asset

asset that is easily and cheaply turned into cash - notably cash itself and short-term securities.


Liquidity risk

The risk that arises from the difficulty of selling an asset. It can be thought of as the difference
between the "true value" of the asset and the likely price, less commissions.


Long-term assets

Value of property, equipment and other capital assets minus the depreciation. This is an
entry in the bookkeeping records of a company, usually on a "cost" basis and thus does not necessarily reflect
the market value of the assets.


Limitation on asset dispositions

A bond covenant that restricts in some way a firm's ability to sell major assets.


Market price of risk

A measure of the extra return, or risk premium, that investors demand to bear risk. The
reward-to-risk ratio of the market portfolio.


Market risk

risk that cannot be diversified away. Related: systematic risk


Mortgage-pipeline risk

The risk associated with taking applications from prospective mortgage borrowers
who may opt to decline to accept a quoted mortgage rate within a certain grace period.


Net asset value (NAV)

The value of a fund's investments. For a mutual fund, the net asset value per share
usually represents the fund's market price, subject to a possible sales or redemption charge. For a closed end
fund, the market price may vary significantly from the net asset value.


Net assets

The difference between total assets on the one hand and current liabilities and noncapitalized longterm
liabilities on the other hand.


Non-reproducible assets

A tangible asset with unique physical properties, like a parcel of land, a mine, or a
work of art.


Nondiversifiable risk

risk that cannot be eliminated by diversification.


Nonsystematic risk

Nonmarket or firm-specific risk factors that can be eliminated by diversification. Also
called unique risk or diversifiable risk. Systematic risk refers to risk factors common to the entire economy.


Operating risk

The inherent or fundamental risk of a firm, without regard to financial risk. The risk that is
created by operating leverage. Also called business risk.


Other current assets

Value of non-cash assets, including prepaid expenses and accounts receivable, due
within 1 year.


Overnight delivery risk

A risk brought about because differences in time zones between settlement centers
require that payment or delivery on one side of a transaction be made without knowing until the next day
whether the funds have been received in an account on the other side. Particularly apparent where delivery
takes place in Europe for payment in dollars in New York.


Policy asset allocation

A long-term asset allocation method, in which the investor seeks to assess an
appropriate long-term "normal" asset mix that represents an ideal blend of controlled risk and enhanced
return.


Political risk

Possibility of the expropriation of assets, changes in tax policy, restrictions on the exchange of
foreign currency, or other changes in the business climate of a country.


Price risk

The risk that the value of a security (or a portfolio) will decline in the future. Or, a type of
mortgage-pipeline risk created in the production segment when loan terms are set for the borrower in advance
of terms being set for secondary market sale. If the general level of rates rises during the production cycle, the
lender may have to sell his originated loans at a discount.


Product risk

A type of mortgage-pipeline risk that occurs when a lender has an unusual loan in production or
inventory but does not have a sale commitment at a prearranged price.


Publicly traded assets

assets that can be traded in a public market, such as the stock market.


Purchasing-power risk

Related: inflation risk


Quick assets

Current assets minus inventories.


Rate risk

In banking, the risk that profits may decline or losses occur because a rise in interest rates forces up
the cost of funding fixed-rate loans or other fixed-rate assets.


Real assets

Identifiable assets, such as buildings, equipment, patents, and trademarks, as distinguished from a
financial obligation.


Regulatory pricing risk

risk that arises when regulators restrict the premium rates that insurance companies
can charge.


Reinvestment risk

The risk that proceeds received in the future will have to be reinvested at a lower potential
interest rate.


Reproducible assets

A tangible asset with physical properties that can be reproduced, such as a building or
machinery.


Residual assets

assets that remain after sufficient assets are dedicated to meet all senior debtholder's claims in full.


Residual risk

Related: unsystematic risk


Return on assets (ROA)

Indicator of profitability. Determined by dividing net income for the past 12 months
by total average assets. Result is shown as a percentage. ROA can be decomposed into return on sales (net
income/sales) multiplied by asset utilization (sales/assets).


Return on total assets

The ratio of earnings available to common stockholders to total assets.



 

 

 

 

 

 

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