Investments Flashcards
Availability heuristic
When a decision maker relies upon knowledge that is readily available in his or her memory, the cognitive heuristic known as “availability” is invoked. This may cause investors to overweight recent events or patterns while paying little attention to longer term trends.
Affect heuristic
Deals with judging something, whether it is good or bad. Do they like or dislike some company based on non-financial issues.
Bounded rationality
When individuals make decisions, their rationality is limited by the available information, the tractability of the decision problem, the cognitive limitations of their minds, and the time available to make the decision. Decision-makers in this view act as “satisficers”, seeking a satisfactory solution rather than an optimal one. One consequence of this concept is that having additional information does not lead to an improvement in decision making due to the inability of investors to consider significant amounts of information.
Illusion of control bias
The tendency for people to overestimate their ability to control events; for example, it occurs when someone feels a sense of control over outcomes that they demonstrably do not influence.
Prospect theory
Provides that people value gains and losses differently and will base their decisions on perceived gains rather than perceived losses. Investors are “loss averse” and have an asymmetric attitude to gains and losses, getting less utility from gaining, say, $100 than they would lose if they lost $100. This explains why investors may avoid higher risk investments even if they offer strong risk adjusted returns. It also explains why they over insure against risks through low deductibles.
Similarity heuristic
Used when a decision or judgment is made when an apparently similar situation occurs even though the situations may have very different outcomes.
NPV
Net Present Value (NPV) is used to evaluate capital expenditures that will result in differing cash flows over the useful life or investment period.
If the NPV is positive or zero, the investor would make the investment. If the NPV is negative, the investor would not make the investment.
NPV = PV of Cash Flows – Initial Cost
Current yield
Current Yield = annual coupon pmt / current price
Relationship between Coupon, Current Yield, YTM, and YTC
Remember that when shopping, if you see a Discount “Call Mom’s Cell Now!” -> Discounts (from highest to lowest) is yield to CALL, yield to Maturity, Current yield, and Nominal yield.
See attached screenshot
Characteristics of UIT’S
passively managed
self-liquidating
Do ADR’s eliminate exchange rate risk?
No!
Frequency of bond interest compounding
Semiannually (unless told otherwise)
Bond rating agencies
• Moody’s ratings are: Aaa - C
Aaa - Baa are investment quality bonds.
Ba and below are junk bonds.
• Standard and Poor’s ratings are: AAA - D
AAA - BBB are investment quality bonds.
BB and below are junk bonds.
Bond price change shortcut
Interest rate % increase or decrease / Duration
Price changes in the OPPOSITE direction as interest rates
