Application of Conditional Expectations in Investments
The conditional expectation, in the context of investments, refers to the expected value of an investment given a certain set of real world events that are relevant to that particular investment. This means that analysts calculate and predict the expected…
Tree Diagram
A tree diagram is a visual representation of all possible future outcomes and the associated probabilities of a random variable. Tree diagrams are particularly useful when we have several possible outcomes. They can help you record all the possibilities in…
Covariance and Correlation
Covariance Covariance is a measure of the degree of co-movement between two random variables. For instance, we could be interested in the degree of co-movement between interest rate and inflation rate. The general formula used to calculate the covariance between…
Portfolio Returns
A portfolio is basically a collection of investments held by a company, mutual fund, or even an individual investor, consisting of assets such as stocks, bonds, or cash equivalents. Financial professionals usually manage a portfolio.
Calculating Covariance Given a Joint Probability Function
Covariance between variables can be calculated in two ways. One method is the historical sample covariance between two random variables \(X_i\) and \(Y_i\). It is based on a sample of past data of size n and is given by: $$\text{Cov}_{X_i,Y_i}=\frac{\sum_{i=1}^{n}{(X_i -\bar{X})(Y_i…
Economies and Diseconomies of Scale
Economies of Scale Economies of scale refer to the cost advantage brought about by an increase in the output of a product. Economies of scale arise due to the inverse relationship between the per-unit fixed cost and the quantity produced…
Price, Marginal Revenue, Marginal Cost, Economic Profit, and the Elasticity of Demand
Marginal revenue (MR) and marginal cost (MC) affect how a company makes its production decisions. Marginal cost (MC) refers to the increase in cost that is occasioned by the production of an extra unit. It is the additional cost of…
Key Rate Duration
The effective duration calculates expected changes in price for a bond or portfolio of bonds given a basis point change in yield. This, however, is only valid for parallel shifts in the yield curve. The key rate duration presents an…
Objectives of Financial Statements
The principles provided by financial reporting standards facilitate the preparation of financial reports which users of financial statements rely on to make informed decisions. The financial reporting framework describes the objectives of financial reporting. Besides, it describes the elements and…
Financial Reporting Standard-setting Bodies and Regulatory Authorities
Standard-setting bodies and regulatory authorities play an integral role in capital market development and supervision. Examples of standard-setting bodies are the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB). The IASB is the standard-setting body…
