FIN2 Flashcards
(39 cards)
(Investor Irrationality) Different types of Information Processing
(FOCS): Forecasting Errors, Overconfidence, Conservatism, Sample size neglect & Representativeness
(Investor Irrationality) Different types of Behavioral Bias
(FMRAP): Framing, Mental Accounting, Regret Avoidance, Affect, Prospect Theory
Futures Characteristics
(MMSE): Market to market, Margin Account, Standardized, Exchange traded
Portfolio Theory - Investors needs to make decisions about:
(CAS): Capital allocation to risky assets, Asset allocation within risky assets, Security Selection
Fisher Equation
Real Rate = (Nominal rate - inf) / (1 + inf)
Return of the complete portfolio
E(rc) = rf + y * ( E(rp) - rf )
Net Asset Value (NAV)
(Market Value - Liabilities) / Shares Outstanding
Beta
Beta is a sensitivity parameter-the higher the beta the higher is the stocks risk-premium in relation to the market risk premium.
Alpha
Non-market risk premium. Positive if if you think the stock is underpriced, negative if you think the stock is overpriced.
SML: Security Market Line
The relationship between a securities return and beta. A stock is a good buy if it plots above the SML (positive alpha). This is a linear function according to CAPM. In equilibrium there are no free lunches.
The Efficient Market Hypothesis
Prices of securities fully reflect available information. Three forms of EMH: weak, semi-strong, strong.
Forecasting Errors
(Information Processing) - People give too much weight to recent experience compared to past when making forecasts.
Overconfidence
(Information Processing) - People tend to overestimate the precision of their forecasts and the they tend to overestimate their abilities.
Conservatism
(Information Processing) - Investors are to slow in updating their beliefs in response to new evidence
Sample size Neglect and Representativeness
(Information Processing) - Many people do not take into account the size of a sample, thus ignoring that a small sample can be very different from the entire population.
Framing
(Behavioral Bias) - How you present the investment can have an effect on the investment decision. An example of framing is that a person may reject an investment when it is posed in terms of risk surrounding potential gains, but may accept the same investment if it is posed in terms of risk surrounding potential losses.
Mental Accounting
(Behavioral Bias) - Form of framing where investors separate decisions.
An investor with low risk aversion may still care a lot about the risk on the children’s savings account. i.e. treat savings differently and not look at the entire savings all together.
Regret Avoidance
(Behavioral Bias) - We regret unconventional decisions failure more than conventional ones
Investing into a large well known company is easier than to invest into a start-up since a failure of the known company can be addressed as bad luck but the startup investment decision may more likely be addressed as a bad investment
Affect
(Behavioral Bias) - Affect is a feeling of good or bad.
Investing in a company with reputations for being socially responsible or environmentally friendly may generate higher affect
Prospect Theory
(Behavioral Bias) - Reformulation of utility functions: we do not care about how rich we are, we care about how much richer we can get-i.e. change in wealth
Sharpe ratio
Measures reward to (total) volatility trade-off. Appropriate when evaluating potential candidates for picking one overall risky portfolio P.
Treynor ratio
As Sharpe ratio it measures reward to risk, but uses systematic risk beta (instead of total risk). Appropriate when looking at many portfolios with the goal of picking several of them to form the overall risky portfolio P (fund of funds).
Jensens alpha
The average return on the portfolio in excess over the return predicted by the CAPM
The information ratio
The Jensens alpha of the portfolio divided by the nonsystematic risk of the portfolio. Appropriate when evaluating candidates for picking an active fund to top up an index fund with.
