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BU457 Study Guide - Final Guide: Portfolio Investment, Risk Aversion, Efficient-Market Hypothesis

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Bixia Xu
Study Guide

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Exam Review Notes
Reserve Recognition Accounting
On the surface, the PV information conforms quite closely to the theoretical
present value model under certainty
However, serious problems of estimation is revealed because oil and gas
companies do not operate under the ideal conditions assumed by the
theoretical model
As a result, reserve information lose reliability, as evidenced by need for
substantial annual revisions and possible bias, as it gains relevance
It ems necessary to trade off these two desirable information qualities
Accounting Under Ideal Conditions
Instead of dwelling on questions of existence of net income, accountants have
turned their efforts to making financial statements more useful
Portfolio Risk
When transactions costs are not ignored, a risk-averse investors optimal
investment decision is to buy relatively few securities, rather than the
market portfolio
In this way, most of the benefits of diversification can be attained, at
reasonable cost
Information about expected returns and betas is useful to investors, as it
enables them to assess the expected returns and riskiness of the portfolios
and choose one that gives them their preferred risk-return tradeoff
Decision Usefulness
Single-person decision theory and its specialization to the portfolio
investment decision provide an understanding of the needs of rational, risk-
averse investors
Such investors need information to help them assess securities expected
returns and the riskiness of these returns
Financial statements are an important and cost-effective source of
information for investors, even though they do not report directly on future
investment payoffs
They provide an information system that can help investors to predict future
firm performance, which, in turn, predicts future investment returns
To enhance this predictive role, accountants need to find the most useful
tradeoff between relevance and reliability
Securities Market Efficiency
Markets being efficient or not efficient is the wrong question. It’s about the
extent of efficiency.
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