Yale - Financial Markets Flashcards
Why was the Yale portfolio primarily in bonds and other “safe” investments?
Yale did not want the strong variation that are common in investment.
Which of the following is NOT an example of moral hazard?
- Lying about farming yields to collect insurance money.
- Neglecting to replace smoke detector batteries when insured against fire.
- Knowingly building a house in an area susceptible to floods.
- Not farming efficiently because farming insurance will cover the cost of a bad crop.
Knowingly building a house in an area susceptible to floods.
This is only an example of moral hazard if you have flood insurance and are incentivized by the insurance company’s willingness to pay for flood damage. Increasing the cost of flood insurance in these areas reduces or eliminates the moral hazard.
All rational investors, seeking to manage risk by optimally diversifying across a common set of different assets:
Ultimately earn the same return if they share the same level of risk-aversion.
N.B. Rational investors sharing the same level of risk-aversion hold the same optimally diversified portfolio.
Hence they earn the same return: the return of the portfolio.
If you want to protect the risk consisting in the fluctuations of the value of your home, you would ideally:
Want to short the market for homes in your city.
As in shorting the stock market, this would allow you to buy back the asset at a lower price if the prices of homes in your city happen to collapse.
Regarding the Efficient Market Hypothesis:
The semi-strong form states all publicly available information about a firm’s prospects are reflected within the firm’s stock price.
Nastya’s makes risky investments with 25% of her portfolio and invests the rest of the portfolio in low-variance investments. This is an example of
Mental compartmentalization.
Nastya mentally separates the portfolio into a risky portion and a non-risky portion instead of looking at the overall risk
Today, the nominal rate of interest is 6% and the inflation rate is 2%. The real rate of interest is therefore:
4%
The real interest rate is calculated by subtracting the inflation rate from the nominal interest rate.
The potential upside of share dilution is that:
The capital received by the company after the dilution can improve the company’s profitability and its stock price.
If both dividends and capital gains are taxed at the same ordinary income tax rate, some difference in the tax effect still exists because:
Dividends are immediately taxed while capital gains are deferred until the stock is sold.
What was the major sign that lead Professor Shiller to predict the crash of the housing market?
Housing prices had been relatively constant for 100 years, but then suddenly started to rise.
How does the Dodd-Frank incentivize banks to only offer mortgages which they believe will not default?
With the exception of Qualifying Residential Mortgages (QRMs), a bank must hold 5% of the mortgages that it initiates.
Examples of tunneling?
- Selling an asset far above or below its value.
- Insider trading.
- Telling friends inside information which helps them exploit a business opportunity.
What is Front Running?
A broker, after receiving a large order from a client, purchases many shares of that stock for herself first (or tells her friends to do so) knowing that this order will cause the price to go up.
Suppose Maria invests in futures. Which of the following is true? HINT: Margin call.
Maria’s margin account will be adjusted each day to account for price changes.
By investing in a futures contract, Maria must be able to pay the price of the future contract as it fluctuates.
Which of the following correctly define backwardation and contango?
Backwardation is when futures prices are below their expected price at maturity, whereas contango is when they are above their expected price at maturity.
