Analysis, Derivates & Funds (Ruby May 17 2015) Flashcards
What happens to the real rate of return on an investment when inflation is high?
What happens to stock prices when inflation is high?
High inflation will reduce the real rate of return on an investments.
For a majority of investors, this low return may not be enough to undertake the risk involved with the investment. This results in a reduced demand for stocks and this leads to lower stock prices.
During a period of high inflation, the manufacturers of an industry will need to pay higher costs for materials and labour. In order to be profitable, the companies will try to pass on the higher costs to consumers, which simply add more inflationary pressure on the economy. Consumers will usually resist the increased prices, leaving the company to absorb some of the cost increases. This reduces profits, and in turn, will result in lower stock prices.
What effect to monetary changes have on businesses and the economy?
When a change occurs in monetary policy, it has the potential to affect a company’s profitability, it essentially tells the company how much of its earnings need to be spent on interest payments. Because this affects the company’s profitability, it will also affect the price of the stock. Policies that stimulate economic activity such as the implementation of low interest rates or increased government spending have a positive effect on stock prices.
What is a period of easy money?
Is a period where interest rates are low and employment is high. Low interest rates allow for more cost effective business expansion which in turn leads to rising stock prices and general economic expansion.
What happens when economy is at the end of the expansion period and the economy has peaked?
Sustained economic growth eventually comes to an end when the economy reaches the end of expansion. At this point in the economic cycle, the BofC may intervene and begin to tighten credit conditions through higher interest rates. These higher interest rates will cause corporate profits to fall as their borrowing costs increase. This in turn will lead to a fall in stock prices.
Cyclical industries.
How do they react and correlate to? Examples of cyclical industries?
Cyclical industries moven in tandem with the performance of the economy, and are particularly sensitive to changes in economic activity. The transportation and construction industries are examples of cyclical industries. Cyclical industries will record record profits during economic expansion and reduced profits during economic slowdowns.
Effect of changes in demographics?
Changes in demographics are expected to create a large demand for some types of consumer products. As the baby boomers grow older, the population is gradually aging. As a result, demand for leisure products and products geared to senior citizens will increase.
Growth companies
Growth companies consist of companies with sales and earnings that increase at a greater rate than other industries, however, over a long period of time. Growth industries are expected to outperform the market as a whole and continue to do so in future years.
Blue chip companies
A blue chip company is a large, nationally or internationally known corporation that has a long, stable record of profit, growth, and dividend payments. They typically have a good reputation for high quality management, products, and services. Blue chip companies generally produce stable returns as a result of size and maturity of the companies.
Current and quick ratio
The current and quick ratio are measure’s of a company’s liquidity, which in turn indicates how readily the company can repay its current liabilities as they come due. The quick ratio is considered to be a more conservative estimate than the current ratio because it excludes the company’s inventory from the calculation.
Quick ratio:
(Current assets - inventories)/Current liabilities
The company with the higher quick and current ratios would be in a better position to pay its obligations as they come due.
Earnings per share
The earnings per share measures how successful the company is at producing earnings to the company’s share price. A steady increase with time implies that the market expects this trend to continue. An increase in demand for the company’s shares will have a positive effect on share price.
Price-to-earnings (P/E) ratio is used to estimate a company’s intrinsic value and is calculated as:
(current market price/earnings per share during the previous year.)
As the share price increases without any changes in the earnings per share, the PE ratio will rise.
Gross profit margin
Measures the profitability on sales after accounting for the cost of goods sold. A decline in this ration may signal problems unrelated to the cost of raw materials and other inputs, such as management decisions of pricing policies.
What does the debt to equity ratio measure?
The debt to equity ratio determines a company’s exposure to debt. It is calculated as:
(total liabilities/total shareholder’s equity) A high debt-equity ratio can suggest the company may have difficulties when trying to meet current debt obligations.
What does a liquidity ratio measure?
A liquidity ratio is a ratio that provides an assessment of how readily a corporation can meet its current debt obligations.
What does the profitability ratio measure?
A profitability ratio is a ratio that measures the efficiency with which a company makes use of it’s assets, by relating profits to factors such as gross sales or capital assets.
What does the equity ratio measure?
An equity ratio measures the extent to which a company has borrowed to finance its business.
What does the value ratio measure?
A value ratio is a ratio that compares the financial condition of a company with its share price.
The price to earnings (P/E ratio) is a ratio that is used to estimate a stock’s intrinsic value and is measured by dividing the current market price of the company’s common shares by earnings per share in the last year. The P/E ratio is a value ratio because it is used to determine if a stock is currently under or over valued. A company with a high PE ration is expected to have strong long term growth prospects.
Fundamental analyst
Is a security analyst who believes that the price of a particular stock ultimately reflects the profitability of the company. The profitability of the company is affected by the overall status of the industry in which the company operates, as well as that of the economy as a whole.
Fundamental analysts on “what” to buy and sell.
Technical analyst
Is a security analyst who believes that investor psychology, and the supply and demand of a market has the greatest affect on a stock’s price. A technical analyst does not care how the company is run, what its profits were in the last year or how much debt the company has.
Technical analysts focus on “when” to buy and sell.
Moving average
Used by technical analysts
A moving average is a series of values that smoothes out the day-to-day fluctuations in a stock’s price allowing the analyst to deduct buy and sell signals.
Is calculated by averaging the stock prices over the most recent period of time, where the period is a fixed number of days.
In rising markets, the daily price fluctuates above the moving average line, which trends upward, indicating a bullish sentiment. If the daily share price drops such that it breaks through the moving average line, it indicates a reversal of the bullish trend, and the technical analyst would likely issue a sell signal on the stock.
In falling markets, the daily price fluctuates below the moving average line, which trends downwards, indicating a bearish sentiment. if the daily price rises such that it breaks through the moving average line, it indicates a reversal of the bearish trend, and the technical analyst would likley issue a buy signal on the stock.
