Key Investment Concepts: Rational Investors, Market Efficiency, Bonds, Stocks, and Analysis Techniques

Rational Investors

That investors make logical decisions to maximize return for a given risk level, using data and not emotions. Example: Choosing a stock based on its strong financial ratios instead of a friend's 'hot tip.'

Efficient Markets hypothesis

That all available information is instantly reflected in asset prices, making it impossible to consistently 'beat the market.' Example: A company's stock price immediately jumps up the second it announces better-than-expected earnings.

Loss Aversion

The idea that the pain of losing money is psychologically more powerful than the pleasure of gaining the same amount. Example: An investor chooses a guaranteed $50 gain over a 50/50 chance to win $100 or $0.

Availability Heuristic

A mental shortcut where people make decisions based on information that comes to mind most easily. Example: After hearing news reports about a plane crash, an investor overestimates the risk of all airline stocks.

Confirmation Bias

The tendency to seek out information that supports your existing beliefs and ignore information that contradicts them. Example: An investor who loves EVs only follows analysts who are bullish on EV stocks and dismisses any negative reports.

Overconfidence Bias

When investors overestimate their own knowledge and ability, leading them to take on excessive risk. Example: A trader makes a few lucky trades and starts believing they are a stock-picking genius, leading to riskier bets and big losses.

Treasury Bill (T-Bill)

A short-term U.S. government debt security with a maturity of one year or less, sold at a discount to its face value. Example: Buying a $10,000 T-Bill for $9,800 and receiving $10,000 when it matures in 3 months.

Coupon Rate

The fixed annual interest payment based on the face value.

Yield

The annual return based on the bond's current market price. Example: A $1,000 bond with a 5% coupon pays $50/year. If you buy it for $800, its yield is $50/$800 = 6.25%.

Secured Bond

A bond backed by specific collateral (assets) that can be sold to repay bondholders if the issuer defaults. Example: An airline issues bonds secured by its airplanes. If it defaults, bondholders can seize and sell the planes.

Callable Bond

A bond that the issuer has the right to repay before its maturity date, usually when interest rates fall. Example: You own a 6% bond. Rates fall to 3%. The company 'calls' your bond, and you are forced to reinvest your money at the new, lower 3% rate.

Zero-Coupon Bond

A bond that pays no periodic interest. It is sold at a deep discount and pays its full face value at maturity. Example: Buying a $1,000 zero-coupon bond for $500 today and receiving $1,000 in 10 years.

Premium (bond)

It is trading for more than its face value.

Bond Premium

It is trading for more than its face value. This happens when its coupon rate is higher than current market interest rates.

TIPS (Treasury Inflation-Protected Securities)

U.S. government bonds where the principal value adjusts with inflation.

Interest Rate Risk

The risk that rising market interest rates will cause the price of existing bonds to fall.

Inverted Yield Curve

It is often a predictor of a recession. It occurs when short-term interest rates are higher than long-term rates.

Bond Duration

A measure of a bond's sensitivity to interest rate changes, expressed in years.

Ex-Dividend Date

The cutoff date to determine which shareholders are eligible to receive an upcoming dividend.

Dividend Yield

Annual Dividends per Share / Current Stock Price.

Portfolio Diversification

Spreading investments across different assets to reduce overall risk. Example: Investing in tech, healthcare, energy, and bonds instead of putting all your money in one tech stock.

Herd Mentality

The tendency to follow the crowd into popular investments without independent analysis. Example: Buying a cryptocurrency because it's trending on social media and everyone seems to be making money.

DRIP (Dividend Reinvestment Plan)

A program that automatically uses dividend payments to purchase more shares of the stock, often without commission.

Stock Dividend

A payment in new shares to existing shareholders.

Stock Split

A division of existing shares to lower the price, without changing the total value of the investment.

Reverse Stock Split

It reduces the number of shares, increasing the share price proportionally, often to meet stock exchange listing requirements.

Preemptive Rights

The right of existing shareholders to buy new shares before they are offered to the public.

Limited Liability

A shareholder's maximum loss is the amount they invested; they are not personally responsible for the company's debts.

Defensive Stock

A stock from a company in an industry that is stable during economic downturns.

Cyclical Stock

A stock whose performance is tied to the health of the economy, rising during booms and falling during recessions.

Growth Stock

From a company expected to grow earnings faster than the market; often reinvests profits and pays no dividends (e.g., tech startups).

Value Stock

Appears undervalued based on fundamentals; often a mature company with a low P/E ratio that may pay dividends.

Primary Market

Where securities are created and sold for the first time (e.g., an IPO).

Secondary Market

Where investors trade existing securities among themselves (e.g., the New York Stock Exchange).

Price-Weighted Index

Stocks are weighted based on their share price. Higher-priced stocks have a greater influence on the index's movement. Example: In the Dow, a $200 stock has 10 times the impact of a $20 stock.

Market-Cap Weighted Index

Stocks are weighted based on their total market value (share price x shares outstanding). Larger companies have a greater influence. Example: Apple has a much bigger impact on the S&P 500 than a much smaller company in the index.

Short Position

The practice of borrowing shares and selling them, hoping to buy them back later at a lower price to return to the lender and profit from the difference. Example: Borrowing 10 shares of Netflix and selling them for $400 each. If the price falls to $300, you buy them back for $3,000, return them, and keep a $1,000 profit (minus fees).

Top-Down Analysis

Starts with the big picture (economy, industry) and then picks the best companies.

Bottom-Up Analysis

Starts by analyzing individual companies (financials, management) regardless of the economy.

Federal Funds Rate

The interest rate banks charge each other for overnight loans. It is a key benchmark for all other interest rates, set by the Federal Reserve.

Business Cycle

The four phases are Expansion, Peak, Contraction, Trough.

Porter's Five Forces

The five key forces that shape industry competition and profitability: 1. Threat of New Entrants 2. Bargaining Power of Suppliers 3. Bargaining Power of Buyers 4. Threat of Substitute Products 5. Intensity of Rivalry.

SWOT Analysis

A company's Strengths, Weaknesses, Opportunities, and Threats.

Current Ratio

A company's ability to pay its short-term obligations with its short-term assets. (Current Assets / Current Liabilities). A ratio above 1 is generally good.

Quick Ratio

It also measures short-term liquidity, but it excludes inventory, focusing only on the most liquid assets (cash, marketable securities, receivables). It's a more conservative test.

Debt-to-Equity Ratio

It shows how much debt a company is using to finance its assets compared to shareholder equity. A high ratio means higher financial risk. (Total Liabilities / Shareholders' Equity).

ROE (Return on Equity)

It measures how efficiently a company is using shareholders' money to generate profits. (Net Income / Shareholders' Equity).

P/E (Price-to-Earnings) Ratio

It shows how much investors are willing to pay for $1 of a company's earnings. A high P/E can mean high growth expectations or an overvalued stock. (Stock Price / Earnings Per Share).

Dividend Payout Ratio

The percentage of a company's earnings paid out as dividends to shareholders. (Dividends per Share / Earnings per Share). A high ratio may leave less for reinvestment.

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