Finance 427 Exam 1 (End of Chapter Questions)

What is a 12b-1 fee?

12b-1 fees are annual fees charged by a mutual fund to pay for marketing and distribution costs.

Find the equivalent taxable yield of the municipal bond in Problem 14 for tax brackets of zero, 10%, 20%, and 30%. B. 10%

= 0.04/ 1 - 0.10 = 0.0444 = 0.0444 or 4.44%

Find the equivalent taxable yield of the municipal bond in Problem 14 for tax brackets of zero, 10%, 20%, and 30%. C. 20%

= 0.04/ 1 - 0.20 = 0.05 = .05 or 5%

Find the equivalent taxable yield of the municipal bond in Problem 14 for tax brackets of zero, 10%, 20%, and 30%. A. Zero

= 0.04/ 1-0 = 0.04 =4%

Suppose that short-term municipal bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after-tax yield if your tax bracket is: A. Zero

= 5% * (1 - 0) = 5%

Suppose that short-term municipal bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after-tax yield if your tax bracket is: B. 10%

= 5% * (1 - 0.10) = 5% * 0.90 = 4.50%

Suppose that short-term municipal bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after-tax yield if your tax bracket is: C. 20%

= 5% * (1 - 0.20) = 5% * 0.80 = 4.00%

Suppose that short-term municipal bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after-tax yield if your tax bracket is: D. 30%

= 5% * (1 - 0.30) = 5% * 0.70 = 3.50%

Find the equivalent taxable yield of the municipal bond in Problem 14 for tax brackets of zero, 10%, 20%, and 30%. D. 30%

=0.04/ 1 - 0.30 = .0571 = .0571 or 5.71%

A portfolio's expected return is 12%, its standard deviation is 20%, and the risk-free rate is 4%. Which of the following would make for the greatest increase in the portfolio's Sharpe ratio? A. An increase of 1% in expected return. B. A decrease of 1% in the risk-free rate. C. A decrease of 1% in its standard deviation.

A and B will have the same impact of increasing the Sharpe ratio from .40 to .45

A market order has:

A market order has price uncertainty but not execution uncertainty

What are the differences between a stop-loss over, a limit sell order, and a market order?

A stop order is a trade is not to be executed unless stock hits a price limit. The stop-loss is used to limit losses when prices are falling. An order specifying a price at which an investor is willing to buy or sell a security is a limit order, while a market order directs the broker to buy or sell at whatever price is available in the market.

In an efficient market, professional portfolio management can offer all of the following benefits except which of the following? a . Low-cost diversification. b . A targeted c . Low-cost record keeping. d . A superior risk-return trade-off

A superior risk-return trade-off.

What are some differences between a unit investment trust and a closed-end fund?

A unit investment trust is an unmanaged mutual fund. Its portfolio is fixed and does not change due to asset trades, as does a close-end fund. And close-end fund is traded on the open market, Unit investment trade is not.

What are some comparative advantages to investing your assets in a Unit-investment Trusts?

A unit investment trust offers low costs and stable portfolios. Since they do not change their portfolios, investors know exactly what they own. They are better suited to sophisticated investors.

Which of the following phenomena would be either consistent with or a violation of the efficient market hypothesis? Explain briefly a . Nearly half of all professionally managed mutual funds are able to outperform the S&P 500 in a typical year. b . Money managers that outperform the market (on a risk-adjusted basis) in one year are likely to outperform in the following year. c . Stock prices tend to be predictably more volatile in January than in other months. d . Stock prices of companies that announce increased earnings in January tend to outperform the market in February. e . Stocks that perform well in one week perform poorly in the following week.

A. Consistant B. Violation C. Consistent D. Violation E. Violation

After Polly Shrum sells a stock, she avoids following it in the media. She is afraid that it may subsequently increase in price. What behavioral characteristic does Shrum have as the basis for her decision making? a . Fear of regret b . Representativeness c . Mental accounting

A. Fear of regret

What options position is associated with: A. The right to buy an asset at a specified price? B. The right to sell an asset at a specified price? C. The obligation to buy an asset at a specified price? D. The obligation to sell an asset at a specified price?

A. Long position in call option ( Buy call option ) B. Long position in put option ( Buy put option ) C. Short position in put option ( Sell put option ) D. Short position in cal option ( Sell call option )

Jill Davis tells her broker that she does not want to sell her stocks that are below the price she paid for them. She believes that if she just holds on to them a little longer, they will recover, at which time she will sell them. What behavioral characteristic does Davis have as the basis for her decision making? a . Loss aversion b . Conservatism c . Representativeness

A. Loss Aversion

Dée Trader opens a brokerage account and purchases 300 shares of Internet Dreams at $40 per share. She borrows $4,000 from her broker to help pay for the purchase. The interest rate on the loan is 8%. (LO 3-4) A. What is the margin in Dée's account when she first purchases the stock? B. If the share price falls to $30 per share by the end of the year, what is the remaining margin in her account? If the maintenance margin requirement is 30%, will she receive a margin call? C. What is the rate of return on her investment?

A. Margin = Value of stock - Loan Value of stock = Number of shares purchased * Purchase price = 300 * $40 = $12,000 Margin = Value of stock - Loan =$12,000- $4,000 = $8,000 B. Value of stock = Number of shares purchased * Purchased Price = 300 * $30 = $9,000 Loan at the end of the year= Amount borrowed * (1 + Interest rate) = $4,000 * (1 + 0.08) = $4,000 * (1.08) = $4,320 Margin = $9,000- $4,320 = $4,680 C. ( Equity Value - Initial Equity / Initial Equity ) ( $4,680 - $8,000/ $8,000) = -41.50%

Suppose that in a wave of pessimism, housing prices fall by 10% across the entire economy. A. Has the stock of real assets of the economy changed? B. Are individuals less wealthy? C. Can you reconcile your answers to ( a) and ( b)

A. No. The real estate in existence has not changed, only the perception of its value has. B. Yes. The financial asset value of the claims on the real estate has changed, and thus the balance sheet of individual investors has been reduced. C. The difference between these two answers reflects the difference between real and financial asset values. Real assets still exist, yet the value of the claims on those assets or the cash flows they generate do change. Thus, there is the difference.

1. Suppose you short-sell 100 shares of a stock selling at $200 a share. A. What is the maximum possible loss? B. What happens to your maximum possible loss if you simultaneously place a stop-buy order at $210?

A. Theoretically, potential losses are unbounded/infinite, growing directly with increases in the price of IBM. In practice, the maximum loss would be based on your collateral and ability (and willingness) to meet margin calls. B. If the price of IBM shares goes above $200, then the stop-buy order would be executed, limiting the losses from the short sale. If the stop-buy order can be filled at $200, the maximum possible loss per share is $10. The total loss is: $10 × 100 shares = $1000. (Remember, with the short sale, the sales price is $200 and the investor repurchases the stock later).

Discuss the advantages and disadvantages of the following forms of managerial compensation in terms of mitigating agency problems, that is, potential conflicts of interest between managers and shareholders. C. A salary linked to the firm's profits.

Advantage- managers feel more motivated and work for the firm to earn more profit, so they also get more profit on their salary Disadvantage- Salary could be more dangerous to the firm if managers manipulate the earnings and profits of the firm to get more profits, can be questioned on accounting practices and transparency in accounting

Discuss the advantages and disadvantages of the following forms of managerial compensation in terms of mitigating agency problems, that is, potential conflicts of interest between managers and shareholders. B. Stock in the firm that must be held for five years.

Advantage- would be to maximize value of shareholders, and managers would also benefit from that. Disadvantage - Risk of managers feeling overburdened.

What are agency problems? What are some approaches to solving them?

Agency problems are conflicts of interest between managers and stockholders.

Describe alternative ways that an investor may add positions in international equity to his or her portfolio.

American Depository Receipts, or ADRs, are certificates traded in U.S. markets that represent ownership in shares of a foreign company. Investors may also purchase shares of foreign companies on foreign exchanges. Lastly, investors may use international mutual funds to own shares indirectly.

What is the difference between an IPO (initial public offering) and an SEO (seasoned equity offering)?

An IPO is the first time a formerly privately-owned company sells stock to the general public. A seasoned issue is the issuance of stock by a company that has already undergone an IPO.

Would you expect a typical open-end fixed income mutual fund to have higher or lower operating expenses than a fixed-income unit investment trust? Why?

An open-end fund will have higher fees since they are actively marketing and managing their investor base.

What are some possible investment implications of the behavioral critique?

An unfortunate consequence of behavioral finance is a tendency for investors to assume more than actually is claimed by the field.

Balanced funds and asset allocation funds invest both the stock and bond markets. What is the difference between these types of funds?

Asset allocation funds may dramatically vary the proportions allocated to each market in accord with the portfolio manager's forecast of the relative performance of each sector. Hence, these funds are engaged in market timing and are not designed to be low-risk investment vehicles.

Why would you expect securitization to take place only in highly developed capital markets?

Because it needs potential investors. It also needs proper allocation of wealth among different securities to create a portfolio. Generally large institutional investors invest in securities to see returns in the future.

Why are the following "effects" considered efficient market anomalies? Are there rational explanations for these effects? a . P/E effect b . Book-to-market effect c . Momentum effect d . Small-firm effect

Because there is historical data to substantiate a claim that says anomalies have produced excess risk-adjusted abnormal returns in the past.

Which of the following most appears to contradict the proposition that the stock market is weakly efficient? Explain. a . Over 25% of mutual funds outperform the market on average. b . Insiders earn abnormal trading profits. c . Every January, the stock market earns abnormal returns.

C. Every January, the stock market earns abnormal returns

Which of the following observations would provide evidence against the semi strong form of the efficient market theory? Explain. a . Mutual fund managers do not on average make superior returns. b . You cannot make superior profits by buying (or selling) stocks after the announcement of an abnormal rise in dividends. c . Low P/E stocks tend to have positive abnormal returns. d . In any year approximately 50% of pension funds outperform the market.

C. Low P/E stocks tend to have positive abnormal returns

Suppose that, after conducting an analysis of past stock prices, you come up with the following observations. Which would appear to contradict the weak form of the efficient market hypothesis? Explain. a . The average rate of return is significantly greater than zero. b . The correlation between the return during a given week and the return during the following week is zero. c . One could have made superior returns by buying stock after a 10% rise in price and selling after a 10% fall. d . One could have made higher-than-average capital gains by holding stocks with low dividend yields.

C. One could have made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.

Why can closed-end funds sell at prices that differ from net value while open-end funds do not?

Close-end funds trade on the open market and are thus subject to market pricing. Open-end funds are sold by the mutual fund and must reflect the NAV of the investments

How does investment banking differ from commercial banking?

Commercial banks is set up for the purpose of concluding commercial transactions, such as legally take deposits and lend money to the customers like individuals and corporates. Investment banks are established to offer services to investors. The operations of investment banks is different, and acts as an intermediary between buyers and sellers of stock and bond, that help clients in raising capital.

What are the key differences between common stock, preferred stock, and corporate bonds?

Common stock is an ownership share in a publicly held corporation. Common shareholders have voting rights and may receive dividends. Preferred stock represents nonvoting shares in a corporation, usually paying a fixed stream of dividends. While corporate bonds are long-term debt issued by corporations, the bonds typically pay semi-annual coupons and return the face value of the bond at maturity.

Why are corporations more apt to hold preferred stock than are other potential investors?

Corporations may exclude 70% of dividends received from domestic corporations in the computation of their taxable income

You've just decided upon your capital allocation for the next year, when you realize that you've underestimated both the expected return and the standard deviation of your risky portfolio by 4%. Will you increase, decrease, or leave unchanged your allocation to risk-free T-bills?

Decrease. Typically, standard deviation exceeds return. Thus, an underestimation of 4% in each wil artificially decrease the return per unit of risk. To return to the proper risk return relationship the portfolio will need to decrease the amount of risk free investments

What is the difference between a primary asset and a derivative asset?

Derivative asset provide payoff that depends on the values of the primary asset, Financial assets have claims on real assets, derivative assets don't

What are the advantages and disadvantages of exchange-traded funds versus mutual funds?

Exchange-traded funds can be traded during the day, just as the stocks they represent. They are most tax effective, & they have much lower transaction costs. They also do not require load charges, management fees, and minimum investment amounts. The disadvantage is that ETFs must be purchased from brokers for a fee.

An investor is in a 30% combined federal plus state tax bracket. If corporate bonds offer 9% yields, what must municipals offer for the investor to prefer them to corporate bonds?

Federal Plus state tax bracket: 30% Corporate Bond Yield: 9% Yield = .09 * (1 - .30) = .0630 = 6.30%

What do we mean by fundamental risk, and why may such risk allow behavioral biases to persist for long periods of time?

Fundamental risk means that even if a security is mispriced, it still can be risky to attempt to exploit the mispricing because the correction to price could happen after the trader's investing horizon.

How does a municipal revenue bond differ from a general obligation bond? Which would you expect to have a lower yield to maturity?

General obligation bonds are backed by the taxing power of the local governments, while revenue bonds have proceeds attached to specific projects. A revenue bond has fewer guarantees, it is riskier in terms of default, and, therefore, you expect it to have a higher yield.

What are some differences between hedge funds and mutual funds?

Hedge funds have much less regulation since they are part of private partnerships and free from most SEC regulation. They permit investors to take on many risks unavailable to mutual funds. Hedge funds, however, may require higher fees and provide less transparency to investors. This offers significant counter party risk and hedge fund investors need to be more careful about the firm they invest with

To estimate the Sharpe ratio of a portfolio from a history of asset returns, we use the difference between the simple (arithmetic) average rate of return and the T-bill rate. Why not use the geometric average?

If inflation increases from 3% to 5% according to the Fisher Equation there will be a concurrent increase in the nominal rate to offsets the increase in expected inflation. This gives investors an unchanged growth of purchasing power

Where would an illiquid security in a developing country most likely trade?

In Broker Markets

"Highly variable stock prices suggest that the market does not know how to price stocks." Respond.

Incorrect. Markets reflect a random pattern.

What are some comparative advantages to investing your assets in Individual Stocks and bonds that you choose for yourself ?

Individual securities offer the most sophisticated investors ultimate flexibility. Investors are able to save money since they are only charged the expenses they incur. All decisions are under the control of the investor

Regret Avoidance

Investors are reluctant to bear losses due to their unconventional decisions.

Disposition effect

Investors are reluctant to sell stocks with "paper" losses

Representativeness bias

Investors disregard sample size when forming views about the future from the past

Mental Accounting

Investors exhibit less risk tolerance in their retirement accounts versus their other stock accounts.

Which of the following statements are true if the efficient market hypothesis holds? a . It implies that future events can be forecast with perfect accuracy. b . It implies that prices reflect all available information. c . It implies that security prices change for no discernible reason. d . It implies that prices do not fluctuate.

It implies that prices reflect all available information.

What is meant by limited liability?

Limited liability means that the most shareholders can lose in event of the failure.

Why have average trade sizes declined in recent years?

Many large investors seek anonymity for fear that their intentions will become known to other investors. Large block trades attract the attention of other traders. By splitting large transactions into smaller trades, investors are better able to retain a degree of anonymity

How do margin trades magnify both the upside potential and downside risk of an investment portfolio?

Margin is a type of leverage that allows investors to post only a portion of the value of the security they purchase. As such, when the price of the security rises or falls, the gain or loss represents a much higher percentage, relative to the actual money invested.

Suppose your expectations regarding the stock market are as follows: State of Economy Probability HPR Boom 0.3 44% Normal Growth 0.4 14 Recession 0.3 -16 Compute the mean and standard deviation of the HPR on stocks.

Mean: (0.3 * 0.44) + (0.4 * 0.14) + [0.3 * -0.16)] = 14% Variance: [0.3 * (0.44 -0.14)^2] + [0.4 * (0.24-0.14)^2] + [0.3 * (-0.16-0.14)^2] = 0.054 SD: Square root of .0054 = 23.24%

Why are money market securities sometimes referred to as "cash equivalents"?

Money market securities are referred to as "cash equivalents" because of their great liquidity. The prices of money market securities are very stable, and they can be converted to cash (i.e., sold) on very short notice and with very low transaction costs

What features of money market securities distinguish them from other fixed-income securities?

Money market securities are short-term, relatively low risk, and highly liquid. Also, their unit value almost never changes

What are the benefits to small investors of investing via mutual funds? What are the costs?

Mutual funds offer many benefits: the ability to invest with small amounts of money, diversification, professional management, relatively low transaction costs and administrative costs. The costs associated with investing in mutual funds are generally operating costs (e.g., management fees), marketing and distribution charges, as well as potential tax inefficiency (for taxable accounts)

Why do financial assets show up as a component of household wealth, but not of national wealth? Why do financial assets still matter for the material well-being of an economy?

National wealth is a measurement of the real assets used to produce GDP in the economy. Financial assets are claims on those assets held by individuals. Financial assets owned by households represent their claims on the real assets of the issuers, and thus show up as wealth to households. Their interests in the issuers, on the other hand, are obligations to the issuers. At the national level, the financial interests and the obligations cancel each other out, so only the real assets are measured as the wealth of the economy. The financial assets are important since they drive the efficient use of real assets and help us allocate resources, specifically in terms of risk return trade-offs.

A successful firm like Microsoft has consistently generated large profits for years. Is this a violation of the EMH?

No, This is not a violation of the EMH. Microsoft's continuing large profits do not imply that stock market investors who purchased Microsoft shares after its success already was evident would have earned a high return on their investments

At a cocktail party, your co-worker tells you that he has beaten the market for each of the last three years. Suppose you believe him. Does this shake your belief in efficient markets?

No. The notion of random walk naturally expects there to be some people who beat the market

What are some comparative advantages to investing your assets in a Open-End Mutual Fund?

Open-end mutual funds offer higher levels of service to investors. The investors do not have any administrative burdens and their money is actively managed. These are better suited for less knowledgeable investors.

If prices are as likely to increase as decrease, why do investors earn positive returns from the market on average?

Over the long haul, there is an expected upward drift in stock prices based on their fair expected rates of return. A fair expected return over any single day is very small {EX: 12% per year is only .03% per day} so that on any day, the price is virtually equally likely to rise or fall. However, over long periods, the small expected daily returns accumulate, and upward moves are indeed more likely than downward ones.

"If all securities are fairly priced, all must offer equal expected rates of return." Comment

Phrase would be correct if it said, "expected risk adjusted returns"

Corporate Fund started the year with a net asset value of $12.50. By year-end, its NAV equaled $12.10. The fund paid year-end distributions of income and capital gains of $1.50. What was the rate of return to an investor in the fund?

Rate of Return = ( 12.1 - 12.5 + 1.5) / 12.5 = 8.8%

What are the differences between real and financial assets?

Real Assets- assets used to produce goods and services Financial Assets- Claims on real assets or the income generated by them

Discuss the advantages and disadvantages of the following forms of managerial compensation in terms of mitigating agency problems, that is, potential conflicts of interest between managers and shareholders. A. A fixed salary.

Refers to the salary structure which is not tied to the profits/sales of the company. Th advantage is that managers look for long-run growth of the company and in result company operate safely without any conflict. Disadvantage is that is that managers are not motivated to take risk for the growth and maximization of the firm value

After reading about three successful investors in The Wall Street Journal you decide that active investing will also provide you with superior trading results. What sort of behavioral tendency are you exhibiting?

Representativeness bias. The sample size is not considered when making future decisions.

In forming a portfolio of two risky assets, what must be true of the correlation coefficient between their returns if there are to be gains from diversification? Explain

So long as the correlation coefficient is below 1.0, the portfolio will benefit from diversification because returns on component securities will not move in perfect lockstep. the portfolio SD will be less than a weighted average of the SD of the component securities.

Which of the following sources of market inefficiency would be most easily exploited? a . A stock price drops suddenly due to a large block sale by an institution. b . A stock is overpriced because traders are restricted from short sales. c . Stocks are overvalued because investors are exuberant over increased productivity in the economy

Stocks are overvalued because investors are exuberant over increased productivity in the economy

Which version of the efficient market hypothesis (weak, semistrong, or strong-form) focuses on the most inclusive set of information?

Strong-form efficiency includes all information: Historical, public, and private

What has been the historical average real rate of return on stocks, Treasury bonds, and Treasury bills?

T-Bills: 3.43% T-Bonds- 5.51% Stocks: 11.91%

Suppose you've estimated that the fifth-percentile value at risk of a portfolio is 230%. Now you wish to estimate the portfolio's first-percentile VaR (the value below which lie 1% of the returns). Will the 1% VaR be greater or less than 230%

The 1% VaR will be less than -30%. As percentile of probability of a return declines so does the magnitude of that return. Thus, a 1 percentile probability will produce a smaller VaR than a 5 percentile probability.

When adding a risky asset to a portfolio of many risky assets, which property of the asset is more important, its standard deviation or its covariance with the other assets? Explain

The Covariance with the other assets is more important. Diversification is accomplished via correlation with other assets. Covariance helps determine that number.

What is meant by the LIBOR rate? The Federal Funds rate?

The London Interbank Offer Rate (LIBOR) is the rate at which large banks in London are willing to lend money among themselves. The Fed funds rate is the rate of interest on very short-term loans among financial institutions in the U.S

Toyota uses $10 million of cash on hand to purchase additional inventory of spare auto parts

The cash is a financial asset that is traded in exchange for a real asset, inventory.

If markets are efficient, what should be the correlation coefficient between stock returns for two nonoverlapping time periods?

The correlation coefficient should be zero. If it were not zero, then one could use returns from one period to predict returns in later periods and therefore earn abnormal profits.

Why are high-tax-bracket investors more inclined to invest in municipal bonds than are low-bracket investors?

The coupons paid by municipal bonds are exempt from federal income tax and from state tax in many states. Therefore, the higher the tax bracket that the investor is in, the more valuable the tax-exempt feature to the investor

What are some different components of the effective costs of buying or selling shares of stock?

The effective price paid or received for a stock includes items such as bid-ask spread, brokerage fees, commissions, and taxes (when applicable). These reduce the amount received by a seller and increase the cost incurred by a buyer.

A municipal bond carries a coupon rate of 6¾% and is trading at par. What would be the equivalent taxable yield of this bond to a taxpayer in a 35% tax bracket?

The equivalent taxable yield is: 6.75% / (1 − 0.35) = 10.3846%

When estimating a Sharpe ratio, would it make sense to use the average excess real return that accounts for inflation?

The excess return on the portfolio will be the same as long as you are consistent, you can use either real rates for the returns on both the portfolio and the risk-free asset, or nominal rate for each.

An investor ponders various allocations to the optimal risky portfolio and risk-free T-bills to construct his complete portfolio. How would the Sharpe ratio of the complete portfolio be affected by this choice?

The expected return of the portfolio will be impacted if the asset allocation is changed. Since the expected return of the portfolio is the first item in the numerator of the Sharpe ratio, the ratio will be changed.

What are the major components of the money market?

The major components of the money market are Treasury bills, certificates of deposit, commercial paper, bankers' acceptances, Eurodollars, repos, reserves, federal funds, and brokers' calls.

What are the strong points of the behavioral critique of the efficient market hypothesis? What are some problems with the critique?

The premise of behavioral finance is that conventional financial theory ignores how real people make decisions and that people make a difference.

What is the difference between a primary and secondary market?

The primary market is the market where newly-issued securities are sold, while the secondary market is the market for trading existing securities. After firms sell their newly-issued stocks to investors in the primary market, new investors purchase stocks from existing investors in the secondary market.

How do security dealers earn their profits?

The primary source of income for a securities dealer is the bid-ask spread. This is the difference between the price at which the dealer is willing to purchase a security and the price at which they are willing to sell the same security.

Toyota takes out a bank loan to finance the construction of a new factory.

Toyota creates a real asset—the factory. The loan is a financial asset that is created in the transaction.

What is the role of an underwriter? A prospectus?

Underwriters purchase securities from the issuing company and resell them. A prospectus is a description of the firm and the security it is issuing.

In what circumstances are private placements more likely to be used than public offerings?

When a firm is a willing buyer of securities and wishes to avoid the extensive time and cost associated with preparing a public issue, it may issue shares privately.

Toyota pays off its loan.

When the loan is repaid, the financial asset is destroyed but the real asset continues to exist.

Wall Street firms have traditionally compensated their traders with a share of the trading profits that they generated. How might this practice have affected traders' willing-ness to assume risk? What is the agency problem this practice engendered?

When traders are compensated with profit it means that their work is appreciated, and they are motivated to reach further targets. Compensation is a kind of encouragement to take more risk and be productive. The traders are compensated with profits when the company earns profit but not penalized when the company incurs losses, so traders may go with more risk.

Why do most professionals consider the Wilshire 5000 a better index of the performance of the broad stock market than the Dow Jones Industrial Average?

While the DJIA has 30 large corporations in the index, it does not represent the overall market nearly as well as the more than 5000 stocks contained in The Wilshire index. The DJIA is simply too small

What is the difference between asset allocation and security selection?

asset allocation is the choice among these broad asset classes for example, comoditites, stocks, bonds, real estate. While the security selection decision is the choice of which particular securities to hold within each asset class.

What are the differences between equity and fixed-income securities?

equity holders are not promised any particular payment. They receive dividends the firm may pay and have prorated ownership in the real assets of the firm. If the firm is for successful, the value will increase, if not it will decrease. For this reason, equity investments tend to be riskier than investments in debt securities

Conservatism Bias

investors are slow to update their beliefs when given new evidence.