Personal Finance and Investments: A Behavioural Finance Perspective

936 Pages·2008·5.67 MB·English

by  Keith Redhead

Personal finance-FM 8/18/08 2:38 PM Page i
Personal Finance and Investments
‘The reader should not expect to find unambiguous answers to all the many questions concerning personal finance and
investments,’ Keith Redhead argues in the preface to this new textbook, thus underlining the role personal judgement
plays in personal finance and investments. Personal judgement should be informed by many perspectives; hence his
interdisciplinary approach to the study of personal finance and investments. In this book, the author draws from finance,
psychology, economics and other disciplines in business and the social sciences, recognising that personal finance and
investments are subjects of study in their own right rather than merely branches of another discipline.
Considerable attention is given to some topics, which are either ignored or given very little attention in other texts.
These include:
■ the psychology of investment decision-making
■ stock market bubbles and crashes
■ property investment
■ the use of derivatives in investment management
■ regulation of investments business.
More traditional subject areas are also thoroughly covered, including:
■ investment analysis
■ portfolio management
■ capital market theory
■ market efficiency
■ international investing
■ bond markets
■ institutional investments
■ option pricing
■ macroeconomics
■ the interpretation of company accounts.
Packed with over one hundred exercises, examples and exhibits and a helpful glossary of key terms, this book will help
the reader to grasp the relevant principles of money management. The book avoids non-essential mathematics and
provides a new approach to the study of personal finance and investments.The book will be essential for students and
researchers engaged with personal finance, investments, behavioural finance, financial derivatives, and financial
economics.
Keith Redhead is Principal Lecturer in the Department of Economics, Finance and Accounting at Coventry University
Business School. He is also the author of Introducing Investments:A Personal Finance Approach and Financial Derivatives:An
Introduction to Futures, Forwards,Options and Swaps.
Personal finance-FM 8/18/08 2:38 PM Page ii
Personal finance-FM 8/18/08 2:38 PM Page iii
Personal Finance and Investments
A behavioural finance perspective
Keith Redhead
Personal finance-FM 8/18/08 2:38 PM Page iv
First published 2008
by Routledge
2 Park Square, Milton Park,Abingdon, Oxon OX14 4RN
Simultaneously published in the USA and Canada
by Routledge
270 Madison Avenue, New York, NY 10016
Routledge is an imprint of the Taylor & Francis Group,an informa business
This edition published in the Taylor & Francis e-Library, 2008.
“To purchase your own copy of this or any of Taylor & Francis or Routledge’s
collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.”
© 2008 Keith Redhead
All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form
or by any electronic, mechanical, or other means, now known or hereafter invented, including
photocopying and recording, or in any information storage or retrieval system, without permission
in writing from the publishers.
British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging in Publication Data
Redhead, Keith, 1949-
Personal finance and investments : a behavioural finance perspective / Keith Redhead.
p. cm.
Includes bibliographical references and index.
ISBN 978-0-415-42859-0 (hb) — ISBN 978-0-415-42862-0 (pb) — ISBN 978-0-203-89563-4
(eb) 1. Investments. 2. Finance, Personal. 3. Investment analysis. 4. Portfolio management. I.Title.
HG4521.R3655 2008
332.6—dc22
2007048856
ISBN 0-203-89563-0 Master e-book ISBN
ISBN10: 0–415–42859–9 (hbk)
ISBN10: 0–415–42862–9 (pbk)
ISBN10: 0–203–89563–0 (ebk)
ISBN13: 978–0–415–42859–0 (hbk)
ISBN13: 978–0–415–42862–0 (pbk)
ISBN13: 978–0–203–89563–4 (ebk)
Personal finance-FM 8/18/08 2:38 PM Page v
For Sue,with love and thanks.
Personal finance-FM 8/18/08 2:38 PM Page vi
Personal finance-FM 8/18/08 2:38 PM Page vii
Contents
Preface xxiv
1 Introduction 1
2 The psychology of personal investment decisions 13
PART 1
Basics of Money, Bond, and Property Markets 53
3 Interest rates and money market investments 55
4 Investing in bonds 72
5 Property investment and mortgages 87
PART 2
Basics of Stock Markets 115
6 Stock exchanges 117
7 Stock indices 131
8 The rationale and conduct of regulation 145
PART 3
Institutional Investments 161
9 Mutual funds (unit trusts, OEICs, investment trusts) 163
10 Life assurance and assurance-related investments 202
11 Pensions 214
12 The importance and significance of institutional investors 242
PART 4
Capital Market Theory 259
13 Portfolio diversification 261
14 Capital market theory:The capital asset pricing model 301
15 Capital market theory:Alternatives and criticisms 318
PART 5
Portfolio Management 329
16 Styles of portfolio construction 331
17 Evaluating the performance of fund managers 368
PART 6
Investment Analysis 391
18 The economic environment 393
19 Dividend discount models 410
20 Company accounts and economic value added 426
21 Ratio analysis 438
22 Technical analysis 454
vii
Personal finance-FM 8/18/08 2:38 PM Page viii
CONTENTS
PART 7
Market Efficiency 477
23 Market efficiency: Concepts and weak form evidence 479
24 Noise trading and behavioural finance 494
25 Market anomalies 513
26 Further evidence on market efficiency 528
27 Stock market bubbles and crashes 540
PART 8
Stock Index Futures 569
28 Stock index futures 571
29 Stock index futures prices 581
30 Hedging with stock index futures 594
PART 9
Stock Options 605
31 Stock options 607
32 Speculation with stock options 622
33 Hedging with options 632
34 Structured products 647
35 Warrants, convertibles, and split-caps 669
36 Option pricing and the Black-Scholes model 680
37 Variations on the basic Black-Scholes option pricing model 690
38 The binomial option pricing model 711
PART 10
International Investing: Using Currency Derivatives 727
39 Currency forwards, futures, swaps, and options 729
PART 11
Bond and Interest Rate Analysis 749
40 Bond prices and redemption yields 751
41 Duration and risk 763
42 Bond price convexity 779
43 Bond futures 785
44 Yield curves and interest rate futures 804
45 Interest rate swaps 820
Glossary 826
References 856
Index 890
viii
Personal finance-FM 8/18/08 2:38 PM Page ix
Detailed Contents
CHAPTER 1 - Introduction 1
Functions of Financial Systems 3
Investors and Borrowers 4
Personal Financial Planning 5
Budgeting 7
Managing Liquidity 7
Financing Large Purchases 7
Long-term Investing 8
Insurance 9
The Nature of Investment Risk 9
CORE Principles of Personal Financial Planning 10
CHAPTER 2 - The psychology of personal investment decisions 13
Choice under Constraint 13
Objectives 13
Types of Risk 14
Constraints 16
Characteristics of Investments 18
Human Capital 19
Risk Management 20
EXHIBIT 2.1: Mis-selling or miscommunication? Apparent mis-selling of financial products may
be the result of different perceptions of risk between advisers and clients
The Psychology of Personal Finance 23
Self-deception 24
Heuristic Simplification 26
The Catering Theory of Dividends 32
The Social Dimension 32
Influence of Emotion and Mood 33
Prospect Theory 34
The Disposition Effect 38
Avoidance of Psychological Biases 40
Saving and Self-Control 40
Habitual Non-Savers 42
Self-control, Personality Traits, and Social Mood 43
Influences on Retirement Saving Behaviour 44
Automatic Enrolment in Pension Schemes 45
Save More Tomorrow (SMarT) 45
Classifying Investors 46
The Need for Targeted Marketing 49
ix