Market, Utiliy, ID curve etc Flashcards
Your opinion about market
It is evident that martkets have changed more complex, dynamic and uncertain than they were 30 years ago, and it certainly will continue.
the fact that demand for people who have critical, analytical, research, communication and teamwork skills to deal with these uncertain market clearly suggest its trend.
Discuss about price, utility and indifference curve
Price is the value measured in the markets for the assets that are traded. To analyze the key segments of the capital markets with an emphasis on prices
• A focus on prices includes several distinct areas:
– The determinants of prices.
– The relationship among various market prices.
– The pattern and distribution of price changes over time.
– The efficiency of markets where prices are determined.
In economics utility describes the level of satisfaction in terms of wealth, from engaging into economic activity. In finance you invest and receive wealth in return, you do this for reason, to increase your wealth, in other words to maximaise your level of satisfaction.
Consider 2 distinct investment opportunity, they have different risk and returns. Therefore we have to see what level of utility these opportunities yield.
If these yield exact same utility, then we combine all these combination with same utility to create indifference curve.( that is a different risk and return combination with same utility)
The reason for these analysis is to allow people to pick assets.
Bear in min people has different risk appetite
Financial market environment,
Why invest?
What assets are in the market?
Essential nature of investment
– Reduced current consumption
– Planned later consumption (increase)
– Increase Utility satisfaction
• Real Assets
– Assets used to produce goods and services
Comapny like BMW, Apple goods and service
• Financial Assets
– Claims on real assets
We are not too interest what apples product, however we want how that product manifests on financial market
Role of financial asset and markets in the economy
It allows people
• Consumption Timing
• Allocation of Risk
• Separation of Ownership
How the Financial System Meets
the Needs of Participants
• Financial Intermediation
Brokers, banks,
• Investment Banking
it allows large scale investments
• Financial Innovation & Derivatives
What are the difference between the financial market in 70s and now?
Technology and Delivery of Service
• Computer advancements
• More complete and timely information
Globalization - Markets are more in line these days
• Domestic firms compete in global markets
• Performance in regions depends on other regions
• Causes additional elements of risk
What are the key trends of globalizations? Securitization? Financial engineering?
Future of the finance?
International and Global Markets Continue Developing
- Managing foreign exchange
- Diversification to improve performance
- Instruments and vehicles continue to develop
- Information and analysis improves ( information pool will be large, but it doesn’t necessarily mean the analysis on it will improve)
more Securitization & Credit Enhancement
• Offers opportunities for investors and originators
• Changes in financial institutions and regulation
• Credit enhancement and its role
• Note role of securitization and financial crises
more Repackaging Services of Financial Intermediaries
• Bundling and unbundling of cash flows
• Slicing and dicing of cash flows
The future looks as
• Globalization continues and offers more opportunities
• Securitization continues to develop
• Continued development of derivatives and exotics
• Integration of investments & corporate
finance
The Changing Financial Landscape
– The Expanding Menu of Financial Choices
– Greater Volatility as a Feature of Financial Markets
– Increased Competition Within and Among
Financial Markets
– Financial Crises and Contagion Among (International) Financial Markets
• Some changes have been gradual.
– The smaller role played by the United States and the U.S. dollar.
– The growing importance of new financial products, new financial institutions, and “emerging” markets around the world.
• Other changes were more abrupt but have long lasting effects.
– The latter half of the 1990s (Mexico, Thailand, Korea, etc.), the financial crises in the 2000s
• The menu of financial choices is expanding.
– Financial engineering: Corporate issuers and private investors have at their disposal innumerable futures and option contracts to acquire or lay off risks associated with economy-wide shocks or with firm-specific events.
• Financial markets have greater volatility now.
– Large price swings over the past three decades led to increased demands for financial forecasting, as well as a greater emphasis on risk management.
There is increased competition within and among financial markets.
– This transformation places new demands on regulators: Should national financial policies and regulations be harmonized or left free to adjust to each country’s individual environment and interests?
• There are financial crises and contagion among (international) financial markets.
– With the increase in size and mobility of capital
(internationally), market reactions are faster, more severe, and broader in scope.
– This new climate raises important questions for the pricing of (foreign) securities and for investor and macroeconomic policies.
Utility and indifference curves
- Assume economic agents want to maximise (wealth) (returns)
- Investors want to maximise Utility
- INVESTOR UTILITY : is the relative satisfaction derived by the investor from the economic activity.
- It depends upon individual tastes and preferences
- It assumes rationality, i.e. people will seek to maximize their utility
- Wealth and utility are positively related
- Marginal Utility measure additional Utility from additional wealth
MARGINAL UTILITY
– each investor has a unique utility-of-wealth function
– incremental or marginal utility differs by individual investor
– 3 Assumptions
• diminishing characteristic - investor risk averse
• Nonsatiation - investor always prefers a higher rate of portfolio return
• Concave utility-of-wealth function
- Fair game/lottery – expected value of zero eg. Toss of coin
- Risk aversion implies that agent does not accept fair game. ie needed extra compensation to take risk
- Concave utility function associated with risk aversion
- Risk averse – diminishing marginal utility of wealth
• Investor’s attitude/view of risk
– Risk Averse – require extra compensation to take fair bet
– Risk Neutral – accept a fair bet
– Risk lover – accept less compensation than fair bet
• Utility function – (non satiation) more preferred to
less eg. U’(W) > 0 for U’(W) = U(W)/(W)
• agent risk averse eg. U’’(W) <0
• Risk aversion can be measured
• Eg. Arrow Pratt Abolute Risk Aversion
(ARA) = -U’’(W)/U’(W)
• Eg. Relative Risk Aversion (RRA) = ARA(W)W
• Eg. of utility functions with different
characteristics – Power, exponential, quadratic
• Utility and portfolio/asset selection can be analyzed through indifference curves
• Indifference curves are a graphical
representation of a set of various risk and expected return combinations that provide the same level of utility
• investor indifferent between combinations of risk and return on indifference curve
