BUS FPX 2062 Assessment 1

BUS FPX 2062 Assessment 1

Student Name

Capella University

BUS-FPX2062 Finance Fundamentals

Prof. Name:

Date

Midpoint Exam

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%

There are no special covenants associated with this security. To calculate the equilibrium rate of return, all risk premiums and the real risk-free rate are added together:

Equilibrium Rate of Return = 4.00% + 2.10% + 3.25% + 0.50% + 1.10% = 10.95%.

Thus, 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 managing a company’s financial actions and ensuring sustainable growth. Their core responsibilities include budgeting, financial planning, risk management, and investment oversight. The CFO ensures compliance with financial regulations and manages cash flow to enhance profitability.

Beyond operational duties, the CFO plays a pivotal role in strategic decision-making by providing insights into business performance, evaluating investment opportunities, and advising on mergers or expansions. During periods of financial uncertainty, the CFO develops contingency plans to stabilize the organization. By aligning financial strategy with long-term goals, the CFO fosters investor confidence and supports the company’s overall success (Brigham & Ehrhardt, 2022).

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

Financial markets are heavily influenced by macroeconomic factors such as interest rates, inflation, and investor sentiment. Higher interest rates make borrowing more expensive, reducing consumer spending and business investment, which often leads to lower stock prices. Conversely, lower interest rates stimulate economic activity and investment, typically increasing stock market returns.

Inflation reduces the purchasing power of money and can negatively affect corporate profits. When inflation rises too quickly, central banks often raise interest rates to control it, which can slow market growth.

Market sentiment—the overall attitude of investors—also plays a crucial role. Positive sentiment encourages investment and market growth, while negative sentiment or economic uncertainty can trigger declines. These three factors collectively shape the direction and volatility of financial markets (Mishkin, 2022).

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

A deposit of $15,000 is planned to be invested for 25 years at an annual interest rate of 5%. The options differ based on compounding frequency as shown below:

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

The results show that more frequent compounding leads to higher returns due to the effects of compound interest over time. Option D (Monthly) provides the greatest future value.

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

To determine the future value (FV) of these payments, the standard annuity formula is used. The calculated future value at the end of six years is $17,883.23. This represents the total amount accumulated, including interest, from consistent annual payments over the investment period.

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

The present value (PV) represents how much that future payment is worth in today’s terms. Using the present value formula:
PV = FV / (1 + r)^t
PV = 4,000 / (1 + 0.085)^6 = $2,451.78.
Therefore, $2,451.78 is the equivalent value of $4,000 received six years from now, discounted at an annual rate of 8.5%.

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

Opportunity cost refers to the value of the next best alternative that must be given up when a decision is made. In personal finance, it helps individuals assess the trade-offs between spending, saving, and investing. For example, if someone keeps a $20,000 bonus in a savings account earning 1% annual interest instead of investing in the stock market, they forgo the potential higher returns that could have been earned through stocks.

In business, opportunity cost helps managers decide between projects or investments by comparing potential returns. Understanding opportunity costs promotes better decision-making, leading to higher long-term financial growth and efficiency (Ross et al., 2022).

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

Junk bonds, also known as high-yield bonds, carry a higher risk of default compared to investment-grade bonds, but they offer greater potential returns to compensate for the added risk.

Type of Bond	Risk Level	Expected Return	Credit Quality
Investment-Grade Bond	Low	Moderate	High
Junk Bond	High	High	Low

Investors might include junk bonds in their portfolios during periods of economic growth, as these bonds can yield higher profits when market conditions are stable. However, they are more vulnerable during downturns due to the weaker financial positions of issuing companies. Major credit rating agencies—Moody’s, S&P Global Ratings, and Fitch Ratings—evaluate and classify these bonds based on their creditworthiness.

9. A company has recorded the following returns on its stock over the past five years: 6%, 10%, 4%, 8%, and 12%.

To measure the volatility of this stock, the standard deviation of returns is calculated as follows:

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

Mean Return = (6 + 10 + 4 + 8 + 12) / 5 = 8%.
Variance = (4 + 4 + 16 + 0 + 16) / 5 = 8.
Standard Deviation = √8 = 2.83%.
Thus, the stock’s standard deviation, representing its volatility, is 2.83%.

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

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 is one of the most common indicators of inflation and reflects how much prices have increased or decreased relative to a base period.

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

• Headline CPI, which includes all items such as food and energy, providing a comprehensive view of inflation.

• Core CPI, which excludes volatile components like food and energy, offering a clearer picture of long-term inflation trends.

CPI helps policymakers, businesses, and consumers make informed financial decisions and adjust wages, interest rates, and budgets accordingly (Bureau of Labor Statistics, 2024).

References

Brigham, E. F., & Ehrhardt, M. C. (2022). Financial Management: Theory and Practice (17th ed.). Cengage Learning.

Mishkin, F. S. (2022). The Economics of Money, Banking, and Financial Markets (13th ed.). Pearson.

Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2022). Fundamentals of Corporate Finance (13th ed.). McGraw-Hill Education.

BUS FPX 2062 Assessment 1

U.S. Bureau of Labor Statistics. (2024). Consumer Price Index: Overview. https://www.bls.gov/cpi/