Finals Flashcards
Practice of spreading your investments around to reduce exposure to risk.
Diversification
Degree of risk that an investor is willing to endure given the volatility in the value of an investment.
Risk Tolerance
Exposure to danger, possibility of failure
Risk
Represents a combination of systematic risk and unsystematic risk, potential internal and external threats
Total Risk
- cannot be predicted
- cannoy be avoided
- undiversifiable risk
- the possibility that an event at the company level could trigger severe instabillity or collapse an entire industry or economy.
Systematic risk
Kinds of Systematic risk
(1) Natural disaster
(2) War & Terrorism
(3) Inflation
(4) Interest rates
(5) Exchange rates
(6) Political instability
(7) Death of the owner
- can be controlled
- can be mitigated
- diversificable risk
Unsystematic Risk
Aspects of Diversification
(1) Diversifying across sector and industries
(2) Diversifying across companies
(3) Diversifying across asset classes
(4) Diversifying across time frames
(5) Diversifying across borders
Investors tendency to favor companies fron their own country over those from other countries or regions
Home Country Bias
Refers to the total value or worth of a comopany. Tells us how much a company is valued at in the stock matket.
Capitalization
Two ways to measure capitalization
(1) Market capitalization
(2) Enterprise value
Determining the value or price of an asset and returns on financial assets, including stocks, bonds, currencies, and real estates.
Asset Pricing
Determining the value or price of an asset and returns on financial assets, including stocks, bonds, currencies, and real estates.
Asset Pricing
Two types of asset pricing
Two types of asset pricing
(1) equity
(2) bonds
Is an idealized portrayal of how financial markets price securities and thereby determine expected returns on capital investments.
Capital Asset Pricing Model
If the required return is less than the estinated return… then
Investors should buy (accept)
If the required return is greater than estimated return… then
Investors should sell (reject)
Are tangible assets with a useful life longer than a year.
Not intended for sale in the regular course of the business’s operation
Capital Assets
Classification of Capital Assets:
(1) Useful life of more than 1 year
(2) Acquisition cost exceeds the company’s designated minimum limit.
(3) Not intended to be sold as part of the business’ operation
Are any profit that you make when you dispose of capital assets.
Capital gains
When asset is sold for a price that is lower than the original purchase price.
Capital loss
If the company purchased an asset lower than the limit, then it is considered as an outright expense.
Not Capital Assets
Is Inventory considered as Capital Assets?
No, because Inventories are part of the business operation and can be sold as part of the operation.
Purpose of categorizing asset as capital assets
(1) for you to know how much income that asset could bring to you
(2) to find investors
A cost is included in the value of an asset and expensed over the useful life of that asset, rather than being expensed in the period the cost was originally incurred.
Assets that can be depreciated
Capiralization in Accounting
Can land be capitalized?
No, because land does not depreciate.
Refers to the amount of outstanding stock, debt, & retained earnings (book value), or may refer to market capitalization.
Capitalization in Finance
Measure of business’ equity and the value of an asset as it appears on a balance sheet.
Book value
The price of an asset would sell for on tbe open market.
Market value
Market where prices represent all relevant financial information about an underlying asset or security.
Market price reflect all available and relevant information.
Market Efficiency
A hypothesis that states that share prices reflect all information and consistent alpha generation.
Argues that markets are efficient, leaving no room to make excess profits by investing since everything is already fairly and accurately priced.
Efficient Market Hypothesis
Term used to assess an assets ability to generate excess returns to a benchmark on the overall market.
Alpha
States that in an efficient market, the stock price is random because you cant predict, as all information is already available to everyone.
Random Walk Theory
Three Forms of Market Efficiency
(1) Weak Form Efficiency
(2) Semi strong Form Effciency
(3) Strong Form Efficiency
All past information is reflected in the market prices.
No form of technical analysis can aid investors
Weak Form Efficiency
All publicly available information is reflected in the current prices.
Investors cannot utilize either technical or fundamental analysis.
Semi Strong Form Efficiency
All public and private information, inclusive of insider trading, is reflected in market prices.
No type of info can give an investor an advantage on the market.
Strong Form Efficiency
Asset prices do not accurately reflect its true value which may occur for several reasons.
Inefficient market/Market Inefficiency
Reasons for Market Inefficiencies
(1) Market Anomalies
(2) Momentum Effect
(3) Small Cap
(4) Insider Trading
Distortions on returns that contradict the efficient market hypothesis.
Market anomalies
Suggests that stocks that have performed well in the past continue to perform well in the future and vice versa
Momentum effect
Smaller companies tend to outperform larger companies over time.
Small cap
Illegal practice of trading on the stock exchange to one’s own advantage
Insider trading
Phenomena that undermine the efficiency of the markets
(1) Behavioral biases
(2) Market bubbles and crashes
(3) Information asymmetry
(4) Market manipulation
Has some characteristics of a developed market, but does not fully meet its standards.
Emerging markets
Risk of Emerging markets
- political instability
- domestic infrastructure problems
- currency volatility
- illiquid equity
Tendency to favor action over inaction, often to our benefit
Bias in action or Action bias
Behavioral biases in action
(1) Myopic loss aversion
(2) Recency bias
(3) Regret aversion
Combination of loss aversion and mental accounting
Myopic loss aversion
Incorrecly believe thag recent events will occur again soon
Recency bias
Make emotional, rather than logical decisions in order to avoid feeling regret
Regret aversion
Selling or disposing of an asset or security.
Disposition
Other types of disposition
- transfer
- assignments
Business also dispose assets
Business disposition
Selling off subsidiary business interest or investments
Divestiture
Types of divestiture
(1) Spin off
(2) Split up
(3) Split off
Creation of new independent company byvselling or distributing new shares of its existing business.
Spin off
Segmenting into two or more separately run entities
Split up
Corporate reorganization method
Split off
Business disposition significance is determined by:
(1) investment test
(2) income test
Investor behavior in which they have a tendency to sell winning investments too early before realizing all potential gains.
Disposition effect
