Stock Investments

An Introduction to Behavioral Finance

Traditionally, economics and finance have focused on models that assume rationality. The behavioral insights have emerged from the application of insights from experimental psychology in finance and economics.

Behavioral finance is relatively a new field which seeks to provide explanation for people’s economic decisions. It is a combination of behavioral and cognitive psychological theory with conventional economics and finance. Inability to maximize the expected utility (EU) of rational investors leads to growth of behavioral finance within the efficient market framework. Behavioral finance is an attempt to resolve inconsistency of Traditional Expected Utility Maximization of rational investors within efficient markets through explanation based on human behavior.… Read the rest

Abey Francis

Children Today Are Smarter Than Ever, Is Your Future Planning Too?

You must be wondering how smart your children are and how they are learning so much beyond their years. For instance, ask your child to open an app on your smartphone, and they would do that in a jiffy.

Studies show that young children are smarter than adults and can imagine, observe and learn new things. If your children are this intelligent; therefore, don’t you want to make sure that they achieve greater heights in their lives?

You know how important a role does education plays in helping your children accomplish their dreams, which is why you should make the best arrangements for them.… Read the rest

Abey Francis

Difference Between Defined Benefit and Defined Contribution Pension Schemes

Pension is a fund that is built during the working life of the employee and then used to secure the income after retirement. These funds can be operated by employer (occupational pension) who invests over time or alternatively employee can invest in a fund of their choice (private pension scheme). Both of these schemes generate income after retirement.

Pension schemes are of two major types:

  1. Defined Benefit Scheme
  2. Defined Contribution Scheme
1. Defined Benefit Scheme

Defined benefit scheme is a type of pension scheme which ensures a particular level of income/benefit after retirement. Most of the cost of the benefit and risk of the investment is borne by the employer however in the contributory define benefit scheme employees also make compulsory contributions.… Read the rest

Abey Francis

Risks Associated with Derivatives

Although derivatives are legitimate and valuable tools for hedging risks, like all financial instruments they create risks that must be managed. Warren Buffett, one of the world’s most wise investors, states that “derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

On one hand derivatives neutralize risks while on the other hand they create risks. In fact there are certain risks inherent in derivatives. Derivatives can be dangerous if not managed properly. Numerous financial disasters such as Enron can be related to the mismanagement of derivatives. In the 1990s, Procter & Gamble lost $157 million in a currency speculation involving dollars and German Marks, Gibson Greetings lost $20 million and Long-Term Capital Management, a hedge fund, lost $4 billion with currency and interest-rate derivatives.… Read the rest

Abey Francis

Fama and French Three Factor Model

Capital Asset Pricing Model (CAPM) is the backbone of modern portfolio theory. According to CAPM, the expected return on stock is a function of its relationship with the market portfolio defined by its beta. However, Eugene Fama and Kenneth French (1992) brought together two more factors and found that stock return is based on a combination of not just market beta but also firm size and value. They came up with a new model known as  Three Factor Model  as an alternative to CAPM.

What is Fama and French Three Factor Model?

Fama and French three factor model expands on the Capital Asset Pricing Model (CAPM) by adding size and value factors in addition to the market risk factor in CAPM.… Read the rest

Abey Francis

Arbitrage Pricing Theory (APT)

A substitute and concurrent theory to the Capital Asset Pricing Model  (CAPM)  is one that incorporates multiple factors in explaining the movement of asset prices. The arbitrage pricing model (APT) on the other hand approaches pricing from a different aspect.    It is rarely successful to analyse portfolio risks by assessing the weighted sum of its components.   Equity portfolios are far more diverse and enormously large for separate component assessment, and the correlation existing between the elements would make a calculation as such untrue.   Rather, the portfolio’s risk should be viewed as a single product’s innate risk.   The APT represents portfolio risk by a factor model that is linear, where returns are a sum of risk factor returns.  … Read the rest

Abey Francis