BUS FPX 2062 Assessment 1

BUS FPX 2062 Assessment 1

Student Name

Capella University

BUS-FPX2062 Finance Fundamentals

Prof. Name

Date

Midpoint Exam

Question 1

Imagine you are evaluating a security. This security has the following associated risks:

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

To calculate the equilibrium rate of return, all individual risk premiums are added to the real risk-free rate. Therefore, the sum of 4.00% (real risk-free rate), 2.10% (inflation risk premium), 3.25% (default risk premium), 0.50% (liquidity risk premium), and 1.10% (maturity risk premium) results in an equilibrium rate of 10.95%.

Question 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) oversees an organization’s financial management and strategic growth. Their core responsibilities include managing budgets, analyzing financial risks, supervising investments, and ensuring regulatory compliance. The CFO plays an essential role in maintaining liquidity and profitability by optimizing cash flow, minimizing costs, and increasing efficiency.

In addition to operational oversight, the CFO collaborates with executive leadership to make strategic decisions that shape the company’s direction. They provide financial insights that influence business expansion, mergers, and capital allocation. During challenging periods, the CFO develops contingency plans to maintain stability. By serving as both a financial guardian and strategic partner, the CFO fosters investor confidence and ensures sustainable long-term success.

Question 3

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

The performance of financial markets is influenced by multiple economic variables, including interest rates, inflation, and investor sentiment. When interest rates increase, borrowing costs rise, which can reduce spending and slow down economic growth, leading to lower stock prices. Conversely, lower interest rates encourage investment, boosting asset values.

Inflation impacts purchasing power and company profits. When inflation rises too rapidly, central banks may raise interest rates to control it, often cooling the markets. Market sentiment—the overall attitude of investors—can also drive volatility. Positive sentiment fosters optimism and price increases, whereas uncertainty or negative news can trigger declines. Together, these factors shape market dynamics and investor decision-making.

Question 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. Your task is to calculate the future value of the account for each compounding frequency after 25 years.

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

As shown in the table, more frequent compounding leads to higher future value due to interest-on-interest growth. Therefore, the monthly compounding option yields the greatest return after 25 years.

Question 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.

The future value of the annuity is $17,883.23. This is computed using the formula for the future value of an ordinary annuity:

[
FV = P times frac{(1 + r)^n – 1}{r}
]

where ( P = 2,500 ), ( r = 0.07 ), and ( n = 6 ).

Question 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.

The present value of the future payment is $2,451.78. The formula applied is:

[
PV = frac{FV}{(1 + r)^n}
]

where ( FV = 4,000 ), ( r = 0.085 ), and ( n = 6 ).

Question 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 benefits forgone from the next best alternative when making a decision. In personal finance, it helps individuals weigh options between saving, investing, and spending. For instance, if someone keeps a $20,000 bonus in a savings account earning 1% annual interest instead of investing in stocks with higher expected returns, they lose the potential for greater long-term growth.

In business investments, understanding opportunity cost helps companies allocate resources efficiently. By evaluating the trade-offs between projects or investments, decision-makers can select the option that maximizes value. Recognizing opportunity cost leads to smarter financial planning and improved long-term profitability.

Question 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, risk, and potential returns. Investment-grade bonds are issued by financially stable entities with a low risk of default, offering lower but safer returns. Junk bonds, conversely, carry higher default risks but compensate investors with higher yields.

Investors may include junk bonds in their portfolios if they have a higher risk tolerance or aim to diversify returns during economic expansions. However, these bonds are sensitive to downturns, as issuing companies often face financial instability. The primary credit rating agencies assessing these bonds are Moody’s Investors Service, S&P Global Ratings, and Fitch Ratings.

Question 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. Please note all work must be shown to receive credit.

Year	Return (%)
1	6
2	10
3	4
4	8
5	12

Mean Return = (6 + 10 + 4 + 8 + 12) / 5 = 8%

Standard Deviation (σ) = √[(Σ(x − μ)²) / (n − 1)]
= √[(4 + 4 + 16 + 0 + 16) / 4]
= √(40 / 4)
= 3.16%

Thus, the stock’s standard deviation is 3.16%, reflecting moderate volatility.

Question 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 standardized basket of goods and services over time. It serves as a key indicator of inflation, revealing shifts in purchasing power and living costs.

The CPI’s basket includes categories such as food, housing, transportation, healthcare, clothing, education, and recreation. The two main types of CPI are:

• Headline CPI: Includes all items, such as food and energy, and tends to be more volatile.

• Core CPI: Excludes food and energy to present a clearer view of long-term inflation trends.

While Headline CPI captures the overall price level, Core CPI helps policymakers focus on stable inflation patterns that guide monetary policy decisions.

References

Investopedia. (2024). Chief financial officer (CFO): Definition, responsibilities, and importance. https://www.investopedia.com

Federal Reserve Bank. (2024). Understanding interest rates and inflation. https://www.federalreserve.gov

BUS FPX 2062 Assessment 1

U.S. Bureau of Labor Statistics. (2024). Consumer Price Index: Measuring inflation and price changes. https://www.bls.gov/cpi

Morningstar. (2024). Bond ratings and risk classifications. https://www.morningstar.com