Book 3 Pages 101 - End Flashcards
an index in which the value of the index is equal to the sum of the prices of the securities in the index divided by a pre-determined dvisior
price weighted index
true or false?
a price weighted index accurately reflects the movement of the underlying market values
false
true or false?
an equal but opposite change in the prices of two stocks would offset each other in a price weighted index
true
which index is an example of a price weighted index?
Dow Jones Industrial Average
the dow jones industrial average consists of mostly ____ _____ stocks
blue chip
true or false?
the dow jones industrial average fails to account for shares outstanding
true
which index is an example of a market capitalization weighted index?
S&P 500
what is the S&P 500 mostly used as a benchmark for?m
US large cap equity
what index is used as a benchmark for small cap stocks?
russell 2000
used as a measure of the US Broad Market securities
Wilshire 500
used as a measure for international securities
Morgan Stanley International Eurpoe, Australia, and Far East Index (MSCIEAFE)
an index based on geometric returns from ~1,700 stocks
value line index
indices that track emerging markets, government debt, and corporate debt asset classes
JP Morgan Indices
first offering of stock to general public by a corporation
IPO - initial public offering
group of investment banks that collectively underwrite a new issue
Syndicate
what is the primary market in regards to issuing securities?
where the initial sale of new securities to the public takes place
what is it called when you assist in the sale of new issues?
underwriting
when the underwriter purchases the entire issue of securities at a specified price and resells at a higher price
firm commitment
when an underwriter purchases securities remaining after an initial offering at a predetermined price
standby underwriting
when an underwriter sells as much of the issue as possible and remainder to the issuing company
best efforts underwriting
true or false?
under firm commitment the risk is shifted to the underwriter
true
true or false?
under standby underwriting all the risk if shifted to the underwriter
false, it is shared between the underwriter and issuing corp
true or false?
under best-efforts underwriting no risk is shifted to the underwriter
true
avoids registration requirements of an IPO
private placement
what is the most popular security when dealing with private placements?
bonds
provides investors with a method of buying and selling previously issued securities
secondary market
an exchange market where listed securities are traded
first market
give an example of first markets
NYSE
an over the counter market with unlisted securities
second market
give an example of a second market
NASDAQ
when stocks trade on both the organized exchanges and OTC
third market
traders who trade without the help of brokers
fourth market
true or false?
fourth market is generally used by institutions who deal in very large volume
true
give an example of a fourth market
INSTINET
executed immediately at the market price
market order
true or false?
market orders have the highest priority
true
order to purchase security at or below specified price or to sell security at or above specified price
limit order
___ priced purchase limit orders take priority over ___ priced limit orders
higher ; lower
___ priced sale limit orders take priority over _____ priced limit orders
lower ; higher
an order to create a limit order if the price of the security reaches a specified level
stop limit order
stocks trading in amounts evenly divisible by 100
round lots
any trade less than 100 shares
odd lot
what is this called .01%
1 basis point
if a bond’s yield drops from 3.35% to 3.22% how many basis points did the bond’s yield drop?
13 basis points
how do you calculate current yield on a bond?
annual interest payments / market price
if Jeff has a bond with an annual coupon of 4.25% that is currently trading at $965, what is the bond’s current yield?
42.5 / 965 = 4.40%
the internal rate of return for cash flows associated with the bond, including the purchase price, coupon, and maturity value
yield to maturity
the longer the term to maturity, the ___ a bond’s price volatility
greater
bonds with ___ coupon rates are more stable when interest rates change than bonds with ____ coupon rates
higher ; lower
a zero coupon bond will be ___ price volatile than a bond with a 4% coupon
more
if a bond gets its rating improved (AA to AAA or other) then the bond’s yield will ____
decrease
bonds with ___ coupon rates and ____ maturities will be most price sensitive to interest rate changes
lower ; longer
states that long term rates consist of many short term rates and their long term rates will be the average or geometric mean of short term rates
unbiased expectations theory
what is the most volatile bond?
a long term zero coupon bond
argues that the yield curve should always slope upward and that any other shape is only a temporary aberration
liquidity preference theory
based on the concept that longer term bonds are more price sensitive to interest rate changes than shorter term bond
liquidity preference theory
implies that investors pay a premium (i.e. lower yields) for shorter maturity bonds to avoid the higher interest rate risk associated with long-term bonds
liquidity preference theory
relies on the concepts of supply and demand for various maturities of borrowing and lending ; these different maturities of borrowing and lending make up different markets
market segmentation theory
states that different institutional investors have different maturity needs that lead them to restrict their bond selections to only predetermined maturity segments
market segmentation theory
determines the weighted average number of years until an investment is recovered
duration
how do you calculate the duration of a bond?
taking the time weighted present value of all cash flows and divide it by the current market price
the coupon rate and duration of a bond have a(n)____ relationship
inverse
true or false?
zero coupon bonds will always have a duration equal to their time to maturity
true
true or false?
a bond with coupon payments will always have a duration less than its time to maturity
true
the duration and YTM of a bond have a(n) ____ relationship
inverse
higher quality bonds (lower yield) will have ____ duration than lower quality bonds (high yield)
greater
an absolute measure of the interest sensitivity of a bond
Macaulay duration
refers to the degree which duration changes as a result of changes in YTM
convexity
the larger the convexity the ___ the change in duration
larger
when is convexity likely to be the greatest?
low coupon bonds
long maturity bonds
low YTM bonds
the coupon rate and convexity of a bond have a(n) ______ relationship
inverse
the term to maturity and convexity of a bond have a(n) ______ relationship
direct
the YTM and convexity of a bond have a(n) ______ relationship
direct
how do you calculate a percent change in the price of a bond?
negative Duration x [ the change in YTM as decimal / (1 + YTM)]
calculate the percent change in the price of the following bond: maturity = 5 years YTM changes from 4.5% to 3.5% annual Coupon rate is 6% (paid annual) Current price is $1,065.85 face value is $1,000
first calculate duration using CF Keys
CF 0 = 0 CF 1 = 60 CF 2 = 120 CF 3 = 180 CF 4 = 240 CF 5 = 300 I = 4.5% NPV = $4,779.28
NPV / Current Price = 4.484 = duration
-4.484 x [ change in YTM / (1+.045) = 4.29%
or you could also use TVM keys
a relative measure for comparing different durations of bonds
modified duration
how do you calculate modified duration?
regular duration / (1 + (YTM / # of coupon payments in a year)
Jose’s bond has a current market value of $821.87 and Macaulay duration of 4.6. If the bond’s yield changes from 3.5% to 4%, what is the percent change in price of the bond?
-2.2%
the present value of future cash flows discounted at a risk adjusted interest rate (IRR)
intrinsic value of a stock
assume an investor can invest in a company who will pay a dividend of $1 in year 1 and increase the dividend by $1 for each of the next 3 years. Assume the stock can be sold at the end of year 4 for $40. How much would an investor be willing to pay if their required rate of return was 12%
use CF keys and NPV
$32.58 is the answer
used to determine the price for a security in which dividends are growing at a constant rate
constant growth dividend discount model
what is the formula for the constant growth dividend discount model?
D1 / (r-g)
assume francis corp stock is currently paying a dividend of $2 and the dividend will grow at a constant 7% rate. What should be the security’s intrinsic value if the investor’s required return is 11%?
d1 = $2 (1+.07) = 2.14
2.14/ (.11-.07) = $53.50
under the constant growth dividend discount model, the value of the common stock will ____ if the required rate of return increases
decrease
under the constant growth dividend discount model, the value of the common stock will ____ if the required rate of return decreases
increase
under the constant growth dividend discount model, the value of the common stock will ____ if the dividend growth rate increases
increase
under the constant growth dividend discount model, the value of the common stock will ____ if the dividend growth rate decreases
decrease
assume francis corp pays a $2 dividend and the investors required return is 11%, what is the value of francis corp’s stock
$18.18
$2 / 11%
how do you calculate the intrinsic value of a stock if there is no dividend growth rate?
Dividend paid / rate of return
assumes the growth rate of the stock’s dividend is not constant but rater changes
multistage growth dividend discount model
when is the multistage growth dividend discount model most appropriate to use?
when a company is going through it’s growth phase
XYZ corp has a current dividend of $2 per share. This dividend is expected to increase 6% for the next 3 years and then 7% thereafter. Assume the investor’s required rate of return is 9%. What is the intrinsic value of the stock?
first find the dividend in year 4 D1 = $2 x 1.06 = $2.12 D2 = $2.12 x 1.06 = $2.25 D3 = $2.25 x 1.06 = $2.39 D4 = $2.39 x 1.07 = $2.56
$2.56 / (.09 - .07) = $128
then plug into cash flow keys
CF 1 = D1
CF 2= D2
CF 3 = D3 + Value of stock at year 4 ($128)
this model should be used when a firm is not currently paying a dividend
Discounted Free Cash Flow Model
what is the formula for the discounted free cash flow model?
Free cash flow to equity(1) / r - g
free cash flow to equity(1) = FCFE(0) x (1+g) / (r-g)
PLV corp has an estimated FCFE for next year of $3 per share. In addition its FCFE is expected to grow at a constant 3% per year. The client’s required rate of return is 10%, what is the stock’s intrinsic value
$3 / (.10-.03) = $42.86
how do you calculate the value of a stock using the capitalized earnings approach?
earnings of company / discount (AKA capitalization) rate
refers to the amount of equity within a company
book value
true or false?
book value depicts an accurate measure of the value of the company
false
a real estate valuation approach that is most appropriate when there are several properties in a market that have been sold that have similar characteristics as the property being valued
the sales comparison approach
a real estate valuation approach that estimates the value of the property by determining how much it would cost to replace the property and then making any adjustments for depreciation or deterioration of the property
the cost approach
when is the cost approach most appropriate to use?
when evaluating special use buildings such as a church or when evaluating newly constructed property
bases the value of the property on the income that can be generated from the property
the income capitalization approach
