Q Explain the nature, scope and applications of behavioral finance. Also, discuss the evolution of rational markets.

O Behavioral finance is an area of study focused on how psychological influences can affect market outcomes.
O Behavioral finance can be analyzed to understand different outcomes across a variety of sectors and industries.
O One of the key aspects of behavioral finance studies is the influence of psychological biases.
O Some common behavioral financial aspects include loss aversion, consensus bias, and familiarity tendencies.
O The efficient market theory which states all equities are priced fairly based on all available public information is often
debunked for not incorporating irrational emotional behavior.
Market evolution refers to changes in primary demand for a product class and changes in technology. For more on
defining your market and target customers, check out How to Do Market Research, Market Research Resources for
Entrepreneurs, and How to Define Your Target Market.According to rational choice theory, rational investors are those
investors that will quickly buy any stocks that are priced too low and short-sell any stocks that are priced too high.

Q Discuss modern portfolio theory and its assumption. Also, explain the importance of MPT for risk management.
Modern Portfolio Theory (MPT) is an investing model in which investors invest with the motive of taking the minimum level
of risk and earning the maximum amount of return for that level of acquired risk. The modern portfolio theory is a helpful
tool for the investors as it helps them in choosing the different types of investments for the purpose of the diversification
of the investment and then making one portfolio by considering all the investments.
Modern Portfolio theory has a certain assumption that is to be considered while making any decisions in order to arrive at
the conclusion that risk, return, and diversification relationships hold true.
MPT quantifies the benefits of diversification, or not putting all of your eggs in one basket. For most investors, the risk
they take when they buy a stock is that the return will be lower than expected. In other words, it is the deviation from the
average return.

Q Discuss in detail the key tenets of prospect theory. What are emotions? Discuss in detail the theories and dimensions of
emotion.
The prospect theory says that investors value gains and losses differently, placing more weight on perceived gains versus
perceived losses. An investor presented with a choice, both equal, will choose the one presented in terms of potential
gains. Prospect theory is also known as the loss-aversion theory.Emotions are very short-lived feelings that come from a
known cause. They are displayed through sudden physical body language and facial expressions, such as by smiling
when happy or crying when sad. Different types of emotions include: happiness, sadness, anger, fear, surprise, and
disgust. Emotion is a complex, subjective experience accompanied by biological and behavioral changes. Emotion
involves feeling, thinking, activation of the nervous system, physiological changes, and behavioral changes such as facial
expressions. Different theories exist regarding how and why people experience emotion.

Q Briefly discuss agency theory and agency cost.

Agency theory is an economic theory that views the firm as a set of contracts among self-interested individuals. An
agency relationship is created when a person (the principal) authorizes another person (the agent) to act on his or her
behalf. An agency cost is an internal expense that comes from an agent taking action on behalf of a principal. Core
inefficiencies, dissatisfactions, and disruptions contribute to agency costs. Agency costs that include fees associated with
managing the needs of conflicting parties are called agency risk.

Q Give a brief note on hyperbolic discounting.

Hyperbolic discounting is a psychological bias where people to prioritize immediate rewards and satisfaction over future
rewards. It's used in sales and marketing to encourage consumers to purchase based on the short-term reward, or instant
gratification. Hyperbolic discounting can result in poor decision-making, because it incentivizes impulsivity and immediate
gratification.1 Decisions that prioritize short-term gratification often neglect and detract from our long-term well-being.
Think of smoking: there is a quick rush of dopamine that is valued over one’s future health. While addiction often plays a
role in people’s decision to smoke, nicotine addiction itself has been linked to an undervaluation of delayed, or long-term
outcomes (ie. impulsivity).

Q Describe how human mind works with the two systems.

Psychologists have been intensely interested for several decades in the two modes of thinking evoked by the picture of
the angry woman and by the multiplication problem, and have offered many labels for them. I adopt terms originally
proposed by the psychologists Keith Stanovich and Richard West, and will refer to two systems in the mind, System 1 and
System 2.
O System 1 operates automatically and quickly, with little or no effort and no sense of voluntary control.
O System 2 allocates attention to the effortful mental activities that demand it, including complex computations. The
operations of System 2 are often associated with the subjective experience of agency, choice, and concentration.
System 1 thinking is a near-instantaneous process; it happens automatically, intuitively, and with little effort. It's driven by
instinct and our experiences. System 2 thinking is slower and requires more effort. It is conscious and logical.

Q Discuss the concepts of mental accounting and mental budgeting.

Mental accounting refers to the different values a person places on the same amount of money, based on subjective
criteria, often with detrimental results. Mental accounting is a concept in the field of behavioral economics. Developed by
economist Richard H. Thaler, it contends that individuals classify funds differently and therefore are prone to irrational
decision-making in their spending and investment behavior.
Mental budgeting focuses on the psychology involved in financial accounting. The theory of mental budgeting argues that
people set budgets and track their expenses against their set budgets (Heath, 1995). Mental budgeting is a psychological
process where money is labeled for particular spending or saving categories.
Q Why study of Behavioral finance is needed in 21st century? Explain the difference between Standard Finance and
Behavioral Finance?
Behavioral finance helps us understand how financial decisions around things like investments, payments, risk, and
personal debt, are greatly influenced by human emotion, biases, and cognitive limitations of the mind in processing and
responding to information.
Behavioral finance is finance with normal people in it, people like you and me. Standard finance, in contrast, is finance
with rational people in it. Normal people are not irrational. Indeed, we are mostly intelligent and usually ‘normal-smart.’ But
sometimes we are ‘normal-stupid,’ swayed by cognitive errors such as hindsight and overconfidence, and misleading
emotions such as exaggerated fear or unrealistic hope. Standard finance is built on four foundation block Behavioral
finance offers an alternative foundation block for each of the foundation blocks of standard finance

Q How does herding tendencies of investors affect the stock market? Explain it in details with examples.
The term herd instinct refers to a phenomenon where people join groups and follow the actions of others under the
assumption that other individuals have already done their research. Herd instincts are common in all aspects of society,
even within the financial sector , where investors follow what they perceive other investors are doing, rather than relying
on their own analysis. People can avoid herding by doing their own research, making their own decisions, and taking
risks.For example The dotcom bubble of the late 1990s and early 2000s is a prime example of the effects of herd instinct.

Q Definition of arbitrageur; Long-short trades; Risk vs. Horizon.

An arbitrageur is a type of investor who attempts to profit from market inefficiencies. These inefficiencies can relate to any
aspect of the markets, whether it is price, dividends, or regulation. The most common form of arbitrage is price. An
arbitrage trade has two legs: one long in the market and one short in the same market, so by being both long and short in
the same market, an arbitrageur doesn’t have to have a strong bullish or bearish inclination toward the market as a whole;
he just has to believe his long position will gain relatively more value (or lose relatively less value) than his short position.
A merger arbitrage takes advantage of market inefficiencies surrounding mergers and acquisitions. Merger arbitrage, also
known as risk arbitrage, is a subset of event-driven investing or trading, which involves exploiting market inefficiencies
before or after a merger or acquisition.

Q Explain the Transaction costs and short-selling costs.

Transaction costs are expenses incurred when buying or selling a good or service. Transaction costs represent the labor
required to bring a good or service to market, giving rise to entire industries dedicated to facilitating exchanges. In a
financial sense, transaction costs include brokers' commissions and spreads, which are the differences between the
price the dealer paid for a security and the price the buyer pays.
Short selling is an investment or trading strategy that speculates on the decline in a stock or other security’s price. It is
an advanced strategy that should only be undertaken by experienced traders and investors.
Traders may use short selling as speculation, and investors or portfolio managers may use it as a hedge against
the downside risk of a long position in the same security or a related one. Speculation carries the possibility of
substantial risk and is an advanced trading method

Q Explain the Fundamental risk; Noise-trader risk.

Fundamental risk is risk that affects entire societies or a large population within a society. Natural disasters, such as
earthquakes and hurricanes, fall into the category of fundamental risk, as do phenomena such as inflation and war, which
typically affect large numbers of people. Noise trader risk is the possibility that well-disciplined and knowledgeable traders
can lose money due to an excess of noise in the market. It is the risk associated with largely uninformed traders who trade
on the noise in the market instead of the signal.

Q Discuss the concept of Behavioral Finance.

Behavioral finance is an area of study focused on how psychological influences can affect market outcomes. Behavioral
finance can be analyzed to understand different outcomes across a variety of sectors and industries. One of the key
aspects of behavioral finance studies is the influence of psychological biases.
O Behavioral finance can be analyzed to understand different outcomes across a variety of sectors and industries.
O One of the key aspects of behavioral finance studies is the influence of psychological biases.
O Some common behavioral financial aspects include loss aversion, consensus bias, and familiarity tendencies.
O The efficient market theory which states all equities are priced fairly based on all available public information is often
debunked for not incorporating irrational emotional behavior.

Q Explain various challenges being faced by behavioral lists

 Lack of money, opportunity and resources, bias, fear, defective conduct of scientific enterprise, etc., are proving great
hurdles to the behaviouralists.
Improving Peoples’ Skills; 0 Improving Quality and Productivity; 0 Total Quality Management (TQM); 0 Managing
Workforce Diversity; 0 Responding to Globalization; 0 Empowering People;0 Coping with Temporariness; 0 Stimulating
Innovation and Change;
Q What are errors in Bernoulli’s theory?
Limitations of Bernoulli's equation are as follows:
1. The Bernoulli equation has been derived by assuming that the velocity of every element of the liquid across any cross-section of
the pipe is uniform. Practically,it is not true. The elements of the liquid in the innermost layer have the maximum velocity. The
velocity of the liquid decreases towards the walls of the pipe. Therefore, we should take into account the mean velocity of the liquid.
2. While deriving Bernoulli's equation, the viscous drag of the liquid has not been taken into consideration. The viscous drag comes
into play, when a liquid is in motion.
3.Bernoulli's equation has been derived on the assumption that there is no loss of energy, when a liquid is in motion. In fact, some
kinetic energy is converted into heat energy and a part of it is lost due to shear force.
4. If the liquid is flowing along a curved path, the energy due to centrifugal force should also be taken into consideration.