Lecture Notes Review - Exam Prep

Flashcards on Bonds, Options, EMH & Behavioral Finance, and Economic Market Analysis

Relationship between interest rate and bond price

There is a negative relationship between interest rates and bond prices. When interest rates rise, bond prices fall; When interest rates drop, bond prices rise.

Discount Bonds

Bonds with a market value that is below face value. Occur when market interest rates are above bond’s coupon rate.

Premium Bonds

Bonds with a market value that is above face value. Occur when market interest rates are below bond’s coupon rate.

Bond from the Investor's Perspective

When investors buy bonds, they are lending money to the bond issuer (e.g., a company or government).

Bond from the Investment Perspective

Fixed-income instruments that represent a loan from investors to issuers like companies or governments. They provide regular interest payments and return the principal at maturity.

Interest Rate Risk

The risk that changes in market interest rates will affect the value of a bond; the most important risk faced by fixed-income investors.

Purchasing Power Risk (Inflation Risk)

The risk that inflation may rise unexpectedly. If bond yields cannot keep up with inflation, the fixed interest payments lose real value, and the bondholder’s purchasing power declines.

Factors Influencing Bond Price

The price of a bond is influenced by three main factors: coupon rate, time to maturity, and changes in market interest rates.

Options (Investment Perspective)

A right given to the option buyer to either buy or sell a specific number of underlying assets at a strike price within a specific period.

Call Option

Holding a right to buy.

Put Option

Holding a right to sell.

Call Option Buyer Profit

Buyers will make profit when share price increases and enough to cover the option premium. When share price increases in the market, option buyers will buy shares from option sellers at strike price and sell to the market at higher price.

Put Option Buyer Profit

Buyers will make profit when share price decreases and enough to cover the option premium. When share price decreases in the market, option buyers will buy shares from the market at lower price and sell to option sellers at strike price.

Call Option Seller Profit

Option sellers will make profit when share price decreases and they earn a premium paid by option buyers.

Put Option Seller Profit

Option sellers will make profit when share price increases and they earn a premium paid by option buyers.

Option Premium

The price an investor pays to buy an option. It is the upfront fee paid to the option seller.

Leverage (Options)

Allows investors to control a large position with less capital, magnifying potential returns compared to buying the underlying asset directly.

Efficient Market Hypothesis (EMH)

All information is fully reflected in the price effectively and accurately. The share price moves randomly, and no one can predict the movement of the share price in the market.

Weak Form EMH

Stock prices fully reflect all past price data. Not used in predicting the future price changes.

Semi-strong Form EMH

Stock price reflects all publicly available information.

Strong Form EMH

Stock price fully reflects all information from public or private sources.

Calendar Effect

Stock returns can be influenced by the time of year or week (e.g., January or weekend effect).

Small-Firm Effect

Size of a firm impacts stock returns. Small firms may offer higher returns than larger firms, even after risk adjustment.

Post Earnings Announcement Drift (Momentum)

Stock price adjustments may continue after earnings adjustments have been announced. Unusually good quarterly earnings reports may signal buying opportunities.

Value Effect

Uses P/E ratio to value stocks. Low P/E stocks may outperform high P/E stocks, even after risk adjustment.

Overconfidence

Investors tend to be overconfident in their judgment, leading them to underestimate risks.

Self-Attribution Bias

Investors take credit for successes and blame others for failures. Investors will follow information that supports their beliefs and ignore conflicting information.

Loss Aversion

Investors dislike losses much more than they like gains. Inventors will hold losing stocks, hoping they will bounce back.

Representativeness

Investors believe that past returns or events are representative of future returns or events, ignoring the probabilistic nature of future outcomes. Investors assume past performance predicts future results, ignoring uncertainty of future outcomes.

Narrow Framing

Investors focus too much on short-term price changes of individual trades without considering the entire portfolio or long-term strategy.

Belief Perseverance

Investors ignore information that conflicts with their existing beliefs, continuing to hold onto stocks despite signs of trouble.

Familiarity Bias

Investors prefer familiar investments, which may lead to underdiversification.

Economic Analysis

Assess the general state of the economy and its potential effects on businesses.

Industry Analysis

Deal with the industry within which a particular company operates. It looks at the overall outlook for that industry and at how companies compete in that industry

Fundamental Analysis

Analyse a specific company’s financial condition and operating result. Include the company’s investment decisions, the liquidity of its assets, its use of debt, its profit margins, and its earning growth

Impact of Strong Economic Growth on Share Prices (Positive)

Boosts corporate earnings and investor confidence.

Impact of High Inflation on Share Prices (Negative)

Leads to higher interest rates, lower P/E ratios, and reduces the appeal of equities.

The Industry Growth Cycle Stages

Initial Development, Rapid Expansion, Mature Growth, Stability or Decline