Class 18

Class 18 - Topics in Finance Behavioral Finance Options...

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Unformatted text preview: Topics in Finance Behavioral Finance Options Mergers and Acquisitions Study of cognitive psychology makes important predictions about human behavior which might affect the decisions financial managers and investors are making Behavioral Finance is a quite new area that might help us explain which we could not otherwise with existing finance theory Behavioral Finance OVERCONFIDENCE Example: 80 percent of drivers consider themselves to be above average Business decisions require judgment of an unknown future Overconfidence results in assuming forecasts are more precise than they actually are OVEROPTIMISM Example: overstating projected cash flows from a project, resulting in a high NPV Overestimate the likelihood of a good outcome Not the same as overconfidence, as someone could be Biases that might affect decisions CONFIRMATION BIAS More weight is given to information that agrees with a preexisting opinion Contradictory information is deemed less reliable SELF-ATTRIBUTION BIAS If the result is nice, it is due to you; if not it is bad luck! Biases that might affect decisions A derivative security is a security whose value is derived from another asset The underlying asset can be anything oil, wheat, currency, interest rate, gold etc. Usually used for hedging or speculation Options are derivative securities where the underlying asset is stocks First started being traded in Chicago Board Options Exchange Derivative Securities Options Call Put Strike or Exercise price Expiration date Option premium Option writer American Option European Option Basic Option Terminology What would be the value of the call at expiration depending on the stock price at expiration?...
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Class 18 - Topics in Finance Behavioral Finance Options...

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