Behavioral Finance and Limits
to Arbitrage
EMH (Efficient Market Hypothesis)
ALL investors act rationally
Prices reflect ALL available information
Behavioral finance
Some investors are not fully rational
People in standard finance are rational. Peop
Factor models
What are Factor models?
A Single Factor Model
Security Characteristic Line
Decomposition of returns into systematic and firmspecific components
Covariances using index models
Multifactor models
1
Factor models: Basic Intuition
Returns
Topics
Portfolios with many risky assets
Efficient frontier of risky assets
Minimum Variance portfolio
Many risky assets and one risk-free asset
Tangent Portfolio
Capital market line
Applications
Allocation of investments across asset classes
Cons
Question
Part
Math
Answer
1a
i
Day 0 Index = (25+45+40)/d = 100
Divisor = 1.1
Day 1 Index = (21+48+42)/1.1 = 100.91
Index Return = 100.91/100 - 1 = 0.91%
Divisor = 1.1
Divisor = 1.1
Index Return = 0.91%
ii
1b
iii
Day 1 Index = (21+48+21)/d = 100.91
Diviso
Topics
Risk and Return
Historical Evidence
Diversification
1
Two dimensions of portfolio performance
Expected Returns
Risk Standard Deviation
Holding Period Return (HPR)
Suppose you buy ABC stock for $100 at time t. You receive $2
dividend in year 1
Capital Asset Pricing Model (CAPM)
A Measure of Risk - Beta
CAPM A model of expected returns
Security Market Line
1
Risk and Expected Return
What portion of a stocks risk is rewarded with bigger expected
returns?
2
Suppose the correlation between A and
1. Define the following terms in about one to three sentences. (1 point each).
a) Wilshire 5000 Index
Wilshire 5000 index is a value-weighted index comprised of all publicly traded
US stocks.
b) Short Rebate
Short rebate is the interest earned on proceeds
Sample Midterm Exam
Duration: 1 hr and 15 min.
Total points = 35.
NAME:_
Note: You are allowed to refer to one sheet of paper that contains ONLY formulas.
Attach the formula sheet to the completed exam.
For the multiple choice questions (2 through 6) choo
Midterm Exam Review
Mutual Funds
Open-end funds
o Various Fees
o NAV
o Passive and Active funds
Closed-end funds and Exchange traded funds
o Closed-end fund discount
o Index ETF
Stock indices
Price-weighted Index
Value-weighted Index
Equal-weighted i
Assignment 1: Due 2-14-2017
Total Points = 100
Work in groups of up to four students. You can form groups across sections.
Please upload a copy of your assignment on Canvas and submit hard copies at the start of
class.
1. (30 points) Use data from the tab
Valuation/Security Analysis
Public
offerings
Stock
research
Buy/Sell/Hold
Valuation
M&A/ Divestitures
How much to pay/sell
for a company/
division?
1
2
3
4
5
Valuation
Fundamental Analysis:
Dividend discount model
Free cash flow model
Relative Valuati
Performance Evaluation
The market model and multi-factor models allow us to
analyze average returns, risk, and investment strategies
Average returns: How much is alpha and how much is beta?
Risk: How much is systematic and how much is idiosyncratic?
Stra
Investments
Narasimhan Jegadeesh
Rm 507, GBS
1
Investments
Course Objectives: The objective of this course is to prepare
students to work in the areas of portfolio management, stock
research and financial advising. The course will primarily
focus on secu