Topic 3: Parts 2 and 3, Topic 4 Flashcards Preview

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Flashcards in Topic 3: Parts 2 and 3, Topic 4 Deck (30):
1

Firms are typically considered risk-averse

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2

Scenario Analysis

Scenario analysis asks the question of how a project performs under given circumstances.
-attribute specific values to each of the factors, then calculate the NPV

3

Sensitivity Analysis

Sensitivity analysis is a particular type of scenario analysis which only considers uni variate changes.
-one variable changes
-predicted variables for all but one
-can asses relative importance of each factor

4

Simulation Analysis

Simulation analysis asks the question of how a project performs under all possible circumstances.
-any number of variables change

5

Mean-Variance Rule
(Only if firms are risk-averse)

Project X is preferred to Y is:
•higher expected return and the same risk
•same expected return and lower risk

6

Departures from Risk-Aversion Assumption

•distressed firms may be GAMBLING for resurrection
•firms with a LARGE DEBT OVERHANG may take excessive risk
•SMALL-SCALE INVESTMENTS which are very risky

7

Risk with multiple projects

To reduce overall risk, firms often aim to implement projects with a negative correlation.

8

Information Efficiency

Information efficiency measures the extent to which available information is impounded into the current set of (stock market) prices.

9

Weak form of market efficiency

Security prices reflect all information found in past trading patterns.

10

Semi-strong form of market efficiency

Security prices reflect all publicly available information.

11

Strong form of market efficiency

Security prices reflect all information, public and private.

12

Mutual Fund Performance
Semi-strong for of efficiency

-public information is already impounded into stock prices
-hence fund managers should not be able to beat the market consistently unless they have access to illegal inside information

13

Mutual Fund Performance

Evidence for semi-strong:
•actively managed funds fail to consistently beat the market
•little persistence in fund performance from year to year
•investing in an index-linked passive fund is often more appropriate for a long term investors

14

Technical Analysis

Technical analysis of the history of share prices and trading patters is the attempt to identify and exploit repetitive patterns.

15

Turn of the Year Anomaly

Stocks which have a bad performance at the end of the (tax) year tend to outperform markets at the start of the new year.
-sell, undervalued, reversion to fundamental value

16

Turn of the Week Anomaly

Stock tends to move more on Fridays than Mondays.
-investors are optimistic at the end of the week
-over the weekend, they fret but cannot trade until Monday

17

Mean Reversion Anomaly

Stocks at either end of the performance spectrum tend to revert course in the following period
-strongest performing stocks are more likely to be somewhat overvalued relative to fundamentals

18

Stock Market Bubble

A stock market bubble occurs when stock market participants drive prices well above their fundamental value.

19

Why may firms change their risk?

•distressed firms gambling for resurrection
•firms with large debt overhang may take excessive risk
•small scale investments which are very risky

20

Opportunity to scrap a project

If we are able to scrap a project after a few periods, our expected NPV increases.

21

Mean-Variance Rule

Project X is preferred to Y:
•higher expected return and equal risk
•same expected return and less risk

22

Negatively correlation

It is better to have negatively correlated projects to reduce overall riskiness.

23

3 arguments for stock market being semi-strong form efficient

•actively managed funds fail to consistently beat the market
•little persistence in fund performance from year to year
•investing in an index-linked passive fund is often more appropriate for a long term investor

24

Why is the weak performance of actively managed funds evidence in favour of semi-strong?

If the semi-strong form of efficiency holds, public information is already impounded into prices and hence fund managers should not be able to beat the market consistently unless they have access to illegal insider information.

25

Argument against strong form efficiency

•strong form efficiency suggests that even insider information does not yield profitable trading opportunities
•some studies exist, ever though insider trading is prohibited, and suggest that insider trading is abnormally profitable
-abnormal returns: returns exceeding the expected return

26

Technical analysis

Technical analysis of the history of share prices and trading patterns is the attempt to identify and exploit repetitive patterns
-focus on past trading pieces and patters to predict whether stock price moves up or down

27

Technical analysis

Technical analysis is bound to yield no profits if the stock market is at least weak form efficient because any information contained in analysis is already impounded into price.
-past trading patterns already analysed and impounded into price

28

Scenario analysis

Scenario analysis asks the question of how a project performs under given circumstances
-multiple uncertain factors, attribute specific values, NPV

29

Sensitivity analysis

Sensitivity analysis is a particular type of scenario analysis which only considers univariate changes
-one variable changes
-predicted variables for all but one

30

Simulation analysis

Simulation analysis asks the question of how a project performs under all possible circumstances
-any number of variables change