VaR: Value at Risk or Variance if the A is capitalized.

it is a numerical value expressed in dollars that

represents the amount of money that can be lost given a probability and time horizon. 1% one-year
VaR of 10 mill means that there is a 1% chance that a given portfolio will lose 10 mill in a year.

Stress Test: Intended to test a firms’ ability to withstand economic crisis, pretends to look at the
details of a portfolio and determine their vulnerability to crisis. Dodd Frank Act

S&P 500 (Standard and poor Index): It’s an average of the performance of 500 company’s Stock it
used as a benchmark for returns.

Betha for a stock is a measure of how much it relates to the stock market technically it’s the
regression slope coefficient when return on the ith asset is regressed on the return of the market.

Market risk represents overall risk idiosyncratic risk represents risk for a firm stock.

The variance of the return of a stock is equal to its beta squared times the variance of the market
return (market risk) plus the variance of the residual in the regression (idiosyncratic risk)

The central limit theorem says that averages of many independent identically distributed shocks of
finite variance are approximately normally distributed.

Risk Pooling is the source of all value in insurance.

Insurance companies are affected by Moral Hazard (People acting carelessly because they have
insurance) and Selection Bias (sick people being more willing to get medical insurance).

Capital Asset Pricing Model (CAPM) says all investors hold their best portfolio, the market is made up
of everyone’s best portfolio, the expected return is based on an asset’s beta.

Stocks outperform gov bonds particularly in USA because the higher risk of stocks needs to be
compensated.

A regression line is one that best fits the scatter points in a chart, if the chart represents a given
stock vs the market then the slope of the line is beta, if the beta is 1 then the stock is in lockstep with
the market if b>1 then the stock overreacts to the market.

Finance innovations

NY was the first state to pass Limited Liability legislation, LL incentivizes greater private investment
because prior to its invention investors faced unlimited liability and the small chance of a loss was
enough to stop business similar to how the small chance of a win keeps people playing the lottery

Indexed debt is an obligation whose value is tied to an index of consumer prices.

Unidad de foment, money provides three functions store value, unit of account and medium of
transaction, unidad de foment sought to take one of those functions from the national currency of
chile to fight off inflation.

Several devices have been proposed to manage risk in the real estate business, among these are the
value insurances and the home put options.
Random walk theory suggests that stock market prices are fundamentally unpredictable.

There are 3 form of market efficiency, Weak form when prices incorporate information about past
prices; semi – strong form when prices incorporate all publicly available information and strong form
when prices incorporate all information including inside information.

Price of stock as present discounted value of expected dividends P= E/(r-g) Gordon Model.

Human capital risk is associated with the present value of a persons future earnings and inflation.

Behavioral finance

Prospect Theory replaces the utility function with value function and the probability with subjective
probabilities generated by a weighting function.

People overestimate probabilities that benefit them

Representativeness Heuristic implies that people tend to see patterns in random data and judge by
similarity to familiar types disregarding probability.

Disjunction Effect inability to make a decision that depends on future information.

Magical Thinking tendency to develop superstition about random events thinking that certain
actions or patterns could cause events to occur when the events are not affected.

Market Capitalization is the number of stocks multiplied by the price of stock for a given company

A corporation is an organization is an artificial person that legally has a lot of the rights that an
individual has, it is a shareholder democracy, the shareholders vote in a board of directors and the
board hires a CEO.

Ownership of company equals the number of shares owned divided by total shares outstanding.

Splits (dividing shares) are meaningless.

If the company pays a dividend, the value of the share should go down by the amount of the
dividend per share.

Ex dividend date is the date when the company pays the dividends.

The corporate charter is the constitution of the corporation.

There are types of stock A and B one has voting rights and the other does not it depends on the
exchange which is which.

Corporations can raise money by issuing new shares (diluting existing shareholders), taking a loan in
a bank, retaining earnings and issuing bonds.

Stocks are called equity because all shareholders are treated equally.

Low P/E means that earnings are forecasted to decrease in future (low g) or that risk is high (high r)

Value investing says invest in low P/E.

A mortgage is a debt instrument secured by the collateral of specified real estate property, that the
borrower is obligated to pay back with a predetermined set of payments.
PMI private mortgage insurance

CMO collateralized mortgage obligations

CDO collateralized debt obligations