BUS FPX 2062 Assessment 1

BUS FPX 2062 Assessment 1

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Name

Capella university

BUS-FPX2062 Finance Fundamentals

Prof. Name

Date

BUS FPX 2062 Assessment 1

Midpoint Exam

1. Imagine you are evaluating a security.

This security has the following associated risks:

• The default risk premium for this security is 3.25%.
• For all securities, the inflation risk premium is 2.10%, and the real risk-free rate is 4.00%.
• Additionally, this security has a liquidity risk premium of 0.50%, and a maturity risk premium of 1.10%.
• There are no special covenants involved in this security.

Given this information, calculate the equilibrium rate of return for this security.

The equilibrium rate of return represents the expected yield that compensates investors for all associated risks. It is calculated by summing the real risk-free rate and all applicable risk premiums.

Component	Rate (%)
Real Risk-Free Rate	4.00
Inflation Risk Premium	2.10
Default Risk Premium	3.25
Liquidity Risk Premium	0.50
Maturity Risk Premium	1.10
Total (Equilibrium Rate)	10.95

Answer: The equilibrium rate of return for this security is 10.95%.

2. What are the primary responsibilities of a chief financial officer (CFO) in an organization, and how does the CFO contribute to both strategic decision-making and the overall financial health of the company?

The Chief Financial Officer (CFO) is responsible for overseeing an organization’s financial operations, ensuring long-term fiscal stability, and supporting strategic planning. Primary duties include budgeting, financial reporting, managing risks, and ensuring compliance with regulatory standards.

The CFO also manages cash flow, reduces unnecessary costs, and enhances profitability through informed investment decisions. Strategically, the CFO collaborates with executive leadership to evaluate expansion opportunities, acquisitions, and technological improvements that optimize efficiency. In times of economic uncertainty, the CFO designs contingency plans to maintain financial resilience. By balancing financial management with strategic insight, the CFO strengthens investor confidence and supports sustainable corporate growth.

3. Explain the impact of factors such as interest rates, inflation, and market sentiment on the performance of financial markets.

Financial markets are significantly influenced by interest rates, inflation, and market sentiment. When interest rates rise, borrowing becomes costlier, discouraging business investment and consumer spending, which can depress stock prices. Conversely, lower rates stimulate economic activity and market growth.

Inflation affects purchasing power and corporate profits. Moderate inflation is generally manageable, but excessive inflation can erode returns and lead to higher interest rates. Market sentiment—driven by investor confidence, news, and global events—also plays a crucial role. Positive sentiment can lead to bullish markets, while uncertainty or negative outlooks often cause declines. Together, these factors interact to shape market volatility and investment behavior.

4. You are considering four different options for a new savings account.

You plan to deposit $15,000 and leave the amount untouched for 25 years, with no additional deposits or withdrawals. All options offer an interest rate of 5%, but they differ in the compounding frequency:

Option	Compounding Frequency	Future Value ($)
A	Annually	50,795.32
B	Semiannually	51,556.63
C	Quarterly	51,951.06
D	Monthly	52,219.36

Answer: After 25 years, the future value of the savings will be highest for Option D (Monthly Compounding) at $52,219.36. This result demonstrates that more frequent compounding leads to greater accumulation over time.

5. You are investing in an annuity that pays $2,500 annually for 6 years, with an interest rate of 7%.

You want to calculate the future value (FV) of these payments at the end of the six-year period.

Answer: The future value of the annuity is $17,883.23. This value represents the accumulated total of equal payments compounded annually at the stated interest rate.

6. You are scheduled to receive $4,000 six years from today, and the discount rate is 8.5%.

Your task is to calculate the present value of this future payment.

Answer: The present value of the $4,000 future payment is $2,451.78, indicating the amount that would need to be invested today to reach $4,000 in six years at an 8.5% return rate.

7. How does the concept of opportunity cost influence decision-making in both personal finance and business investments?

Provide an example of a situation where choosing one alternative results in the loss of potential gain from other alternatives, and explain how understanding opportunity cost can lead to better decision-making.

Opportunity cost represents the potential benefit lost when one alternative is chosen over another. In personal finance, it helps individuals weigh the potential returns of different investment options.

For instance, if a person keeps a $20,000 bonus in a savings account earning 1% interest rather than investing it in stocks with higher expected returns, they forgo the potential for substantial growth. In business, opportunity cost influences decisions like allocating capital to new projects or expanding into new markets. Understanding this concept encourages better long-term decision-making by evaluating trade-offs and prioritizing options that maximize returns.

8. What is a junk bond, and how does it differ from investment-grade bonds in terms of risk and return?

Additionally, discuss the circumstances under which investors might choose to include junk bonds in their portfolios and the potential benefits and drawbacks of doing so.

Junk bonds differ from investment-grade bonds primarily in terms of credit quality and associated risk. Junk bonds carry a higher risk of default but offer higher yields to compensate for this risk. Investment-grade bonds, by contrast, are issued by financially stable entities and offer lower, more secure returns.

Investors may include junk bonds in their portfolios when economic conditions are strong and their risk tolerance allows for potential volatility. While junk bonds can enhance portfolio returns, they are more vulnerable to downturns. Major rating agencies such as Moody’s, S&P Global Ratings, and Fitch Ratings classify bonds to indicate creditworthiness. Therefore, investing in junk bonds can be advantageous during economic expansions but risky during recessions.

Bond Type	Risk Level	Potential Return	Economic Sensitivity
Investment-Grade Bonds	Low	Moderate	Low
Junk Bonds	High	High	High

9. A company has recorded the following returns on its stock over the past five years:

6%, 10%, 4%, 8%, and 12%.
Calculate the standard deviation of the stock’s returns to assess the volatility of the stock.

To measure volatility, the standard deviation formula is applied.

[
sigma = sqrt{frac{sum (x_i – bar{x})^2}{n-1}}
]

Year	Return (%)	Deviation from Mean (×)	Squared Deviation (ײ)
1	6	-2	4
2	10	2	4
3	4	-4	16
4	8	0	0
5	12	4	16

Mean (𝑥̄) = 8%
Variance = (4 + 4 + 16 + 0 + 16) / 4 = 10
Standard Deviation (σ) = √10 = 3.16%

Answer: The standard deviation of the stock’s returns is 3.16%, indicating moderate volatility.

10. What is the Consumer Price Index (CPI), and how is it used to measure inflation in an economy?

Please explain which basket of goods and services are used to calculate the CPI.

The Consumer Price Index (CPI) measures the average change in prices paid by consumers for a fixed basket of goods and services over time. It serves as a key indicator of inflation and purchasing power in an economy.

The CPI basket typically includes categories such as food, housing, apparel, transportation, healthcare, education, and recreation. It is calculated by comparing the cost of this basket during the current period to its cost in a designated base period.

There are two main types of CPI:

• Headline CPI: Includes all goods and services, including food and energy, making it more volatile.
• Core CPI: Excludes food and energy prices, offering a clearer view of long-term inflation trends.

While Headline CPI reflects overall inflation, Core CPI provides policymakers with insights into underlying economic pressures.

References

Investopedia. (n.d.). Chief financial officer (CFO): Definition and role. https://www.investopedia.com

Investopedia. (n.d.). Opportunity cost: Definition and examples. https://www.investopedia.com

U.S. Bureau of Labor Statistics. (n.d.). Consumer Price Index (CPI): Overview. https://www.bls.gov/cpi

Corporate Finance Institute (CFI). (n.d.). Junk bonds vs. investment-grade bonds. https://corporatefinanceinstitute.com

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