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These flashcards cover key concepts and theories in finance, providing definitions and explanations for important terms.

Classical finance theory

Developed in the 1950s-1960s, focuses on the relationship between capital structure, investment, and firm value under perfect market assumptions.

Modigliani-Miller theorem

States that capital structure is irrelevant in perfect markets.

Dividend irrelevance theory

Firm value is independent of its dividend policy.

Fisher separation theorem

Investment decisions can be made independently of shareholders' preferences.

Criticisms of classical finance theory

Ignores market imperfections such as taxes, transaction costs, and asymmetric information.

Neoclassical finance theory

Dominant from the 1960s to 1980s, it explores asset pricing and risk-return relationships using mathematical and statistical models.

Capital Asset Pricing Model (CAPM)

Describes the relationship between risk and expected return.

Efficient Market Hypothesis (EMH)

Posits that prices fully reflect all available information.

Portfolio Theory (Markowitz)

Focuses on optimal portfolio diversification to maximize returns for a given level of risk.

Criticisms of neoclassical finance theory

Assumes rational investors, efficient markets, and normal distribution of returns, which often deviate from reality.

Neo-institutional finance theory

Emerged between the 1970s and 1990s, focuses on institutions, governance, and transaction costs in financial decision-making.

Agency theory

Explores conflicts between principals (shareholders) and agents (managers).

Transaction cost theory

Assesses the impact of transaction costs on financial decisions.

Property rights theory

Suggests ownership structures affect firm behavior and efficiency.

Criticisms of neo-institutional finance theory

Relies on assumptions of rational behavior and neglects behavioral aspects of finance.

Behavioral finance

Studies how psychological biases and irrational behaviors affect financial decisions and market outcomes (from 1980s to present)

Prospect theory

Explains that investors value gains and losses relative to a reference point.

Heuristics and biases

Systematic errors in judgment, such as overconfidence, anchoring, and mental accounting.

Classical finance theories

Modigliani-Miller

Dividend irrelevance theory

Fisher separation theorem

Neoclassical theories

CAPM

EMH

Portfolio theory (Markowitz)

Neo-institutional finance theories

Agency theory

Transaction cost theory

Property rights theory

Behavioral finance theories

Prospect theories

Heuristics and biases

Biases even for CEOs

Criticisms of behavioral finance

Lacks a unified theoretical framework and often challenges predictability in markets

Application of classical finance theory

Determining optimal capital allocation and financial structure

Application of neoclassical finance theory

Evaluating financial assets and creating efficient investment portfolios

Application of neo-institutional finance theory

Analyzing agency problems, transactions costs and ownership structures

Application or behavioral finance

Understanding market anomalies, bubbles and investor behavior

Criticisms of behavioral finance

Lacks a unified theoretical framework and often challenges predictability in markets

Sustainable finance

Focuses on integrating ESG factors into financial decisions (from 2000s to present)

Application of sustainable finance

Promoting long-term value creation and addressing sustainability challenges

Sustainable finance theories

Double materiality

Stakeholder theory

Impact investing

Double materiality

Financial and non-financial impact of corporate actions, i.e., 1.) how do (ESG) factors affect a company’s financial performance 2.) how does a company’s activities affect the environment and society?

Stakeholder theory

Importance of balancing interests of all stakeholders.

Impact investing

Investments generating measurable social and environmental impact

Criticisms of sustainable finance

Lack of standardization in ESG metrics and potential for greenwashing