BFF1001 Lecture Notes - Lecture 2: Deflation, Official Cash Rate, Government Debt
Rate of Return
Investments and assets in the economy are recognised as risky or risky free.
Risk in finance is defined as uncertainty of future cash flows. Most assets have
some risk, some element of future uncertainty in their earnings.
However, it is widely accepted that government debt (treasury bonds and bills)
is a risk-free investment, as there will be a government to make claims on
The existence of a risk free asset which provides a risk-free rate of return is vital
foundation of finance.
As all other assets in the economy have some risk, a risk-free provides a
benchmark for performance.
All risky assets should earn E(R)> Risk free rate of return or Ri
Otherwise, why buy a risky asset, where you may loose some or all of your
future return, when you can buy the risk-free asset and have a guaranteed future
return.
This leads to understanding of the concept of a premium, which is a rate of
return above a benchmark
Risk premium = E(R) Asset – Rf = The rate of return for bearing risk
For example: if you can earn 4% risk-free and earn 10% from a risky asset,
10%-4% = 6% is what you can earn for taking a risk, i.e the risk premium.
The default risk free assets in an economy are Government debt, for long-term
investments, Government bonds. So if a government bond is yielding or paying
3% interest, a RF used for long-term asset benchmarking is 3%.
• The RBA is responsible for monetary policy, the payments system and
the stability of the entire financial system.
• APRA is responsible for prudential supervision of financial institutions
including banks, credit unions, building societies, insurance and
superannuation companies.
• ASIC is responsible for the enforcement of company and financial
services laws. The objective is to protect consumers, investors and
creditors.
• ASIC is also responsible for licensing and monitoring financial
markets, financial instruments and advisors as well as monitoring the
disclosure and conduct of Australian companies and services providers.
What does the RBA do? It is Australia‟s Central bank.
The determination and implementation of monetary policy
Issuing Australian currency notes
Overseeing the payments system
Acting as the government‟s banker
Issuing and providing the market for treasury securities
Managing financial system liquidity and the government‟s holding of
foreign exchange.
Why is the RBA important in finance?
It plays a prime role in determining the cost of debt capital in the economy.
What is Monetary Policy?
Document Summary
Investments and assets in the economy are recognised as risky or risky free. Risk in finance is defined as uncertainty of future cash flows. Most assets have some risk, some element of future uncertainty in their earnings. However, it is widely accepted that government debt (treasury bonds and bills) is a risk-free investment, as there will be a government to make claims on. The existence of a risk free asset which provides a risk-free rate of return is vital foundation of finance. As all other assets in the economy have some risk, a risk-free provides a benchmark for performance. All risky assets should earn e(r)> risk free rate of return or ri. Otherwise, why buy a risky asset, where you may loose some or all of your future return, when you can buy the risk-free asset and have a guaranteed future return.
