Basic Tools of Finance (Block 2) Flashcards
Final (Chapter 14)
Future Value
The value of an asset or investment at a specified date in the future, based on a certain interest rate or rate of return.
Present value
The current value of a future sum of money or stream of cash flows, discounted back to the present at a specified rate of return.
Risk aversion
A preference for certainty over uncertainty when it comes to financial decisions.
Utility representation
Different individuals have varying degrees of risk tolerance, represented by their utility functions.
Degrees of Risks
- Risk averse: Prefer certain outcomes over uncertain ones, willing to accept lower returns to avoid risk.
- Risk neutral: Indifferent between certain and uncertain outcomes, focusing solely on expected returns.
- Risk lover: Prefer uncertain outcomes with higher potential returns, willing to accept higher risk.
Diversification
Spreading investments across different assets or securities to reduce risk.
Market risk
The risk inherent in the entire market or a particular segment of it, affecting all investments to some degree.
Firm-specific risk
Risk that affects only a specific company or industry, unrelated to broader market movements.
Stock pricing
Determining the fair value of a stock based on its fundamentals, such as earnings, dividends, and growth prospects.
Efficient market hypothesis
The theory that asset prices fully reflect all available information and therefore, it is impossible to consistently outperform the market.
Implications
Investors cannot consistently earn abnormal returns through stock picking or market timing, as prices quickly adjust to new information.
Market Irrationality
Instances where market prices deviate from their fundamental values due to irrational investor behavior, such as herding, overreaction, or underreaction.
