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IESE MBA Term 1 > Capital Markets > Flashcards

Capital Markets Flashcards

1
Q

The sensitivity of a firm´s earnings to the business cycle depends on this 3 factors:

A
  1. Sensitivity of sales
    Low: necessities (food, drugs and medical devices)/low demand elasticity (tobacco)
    High: cars, machine tools, steel
  2. Operating leverage: Fixed cost/Variable cost
    Higher operating leverage, more sensitiviy
    Higher VC, less sensitivity to business cycles
  3. Financial leverage: use of borrowing
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2
Q

Firm A has low fixed costs and high variable costs
Firm B has high fixed costs and low variable costs
Which firm will perform better in
I. Recession
II. Expansion

A

I. Firm A: can adapt to lower production

II. Firm B: costs don´t increase with revenues as with Firm A

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3
Q

Degree of operating leverage DOL=

A

% change in profits/% change in sales
If DOL >1, firm has some operating leverage
% change is the difference between the normal and the recession scenario
Better to have a Low DOL

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4
Q

DOL = 2 means

A

For every 1% change in sales, profits will change by 2% in the same direction

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5
Q

How is DOL related to Fixed costs and profits

A

DOL = 1 + FC/Profits

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6
Q

What is Sector Rotation

A

Shift the portfolio more heavily into industry or sector groups that are expected to outperform based on assessment of the state of the business cycle

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7
Q

What are cash cows

A

Firms in mature industries that have stable dividends and cash flows and little risks

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8
Q

During expansion in which industries should you invest

A
  1. Consumer discretionary
  2. Materials
  3. Industrials
  4. Energy
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9
Q

During contraction in which industries should you invest

A

Healthcare
Consumer staples
Utilities
Financials

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10
Q

According Lynch´s framework, Slow Growers are

A

Large and aging companies that will grow only slightly faster than the broad economy. Have steady cash flow and pay a generous dividends, indicating that the firm is generating more cash than can be profitably reinvest in the firm

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11
Q

According Lynch´s framework Stalwarts are

A

Large, well-known firms like Coca Cola, Hershey or Colgate The grow faster than the slow growers but are not in the rapid growth start-up stage. Tend to be non cyclical industries

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12
Q

According Lynch´s framework Cyclicals are

A

Firms with sales and profits that regularly expand and contract along with the business cycle: auto, steel and construction companies

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13
Q

According Lynch´s framework Turnarounds are

A

Firms that are in bankruptcy or soon might be. If they can recover, they may offer high investment returns. F.e Chrysler in 1982

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14
Q

According Lynch´s framework Asset Plays are

A

Firms that have valuable assets not currently reflected in the stock price. It could be real estate assets or intangible assets

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15
Q

What are the 3 main activities of an Investment Bank?

A

Invest in capital markets, research, advise deals

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16
Q

What was the purpose of the Glass Stegal Act of 1933?

A

Separate commercial banks from investment banks after the 1929 crash

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17
Q

What happen on May Day in 1975?

A

SEC deregulated the brokerage fees: trading fees would be set by market competition, instead of a fixed price. Consequence= fees decreased

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18
Q

In terms of market regulation, what happen after 1999

A

The Glass Stegal Act was repeal = commercial banks can also be investment banks

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19
Q

Regarding hedge funds and private equity funds, the Dodd Frank Act of 2010 key regulation point is

A

Volcker rule: prohibits banks from trading for their own accounts (proprietary trading) and limits total investments on hedge funds or private equity

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20
Q

What financial assets represents?

A

How the ownership of real assets is distributed among investors

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21
Q

What are the different kinds of financial assets?

A

Stocks, Bonds, Commodities, Currencies, Interests Rates, Derivates

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22
Q

What are the different divisions on the sale side of an investment bank?

A

Investment Banking Division, Markets (Trading) Division, Research Division and Back Office (IT, Risk Compliance)

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23
Q

What are the area within the Investment Banking division and what they do?

A
  1. M&A =valuation and negotiation

2. Corporate finance= advise on the financial structure of a company: equity (IPO) or debt bond insurance

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24
Q

What is the difference between primary and secondary market?

A 
Primary= new issues of securities (IPO in case of stocks)
Secondary= already-issued securities
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25
Q

What IPO stands for?

A

Initial Public Offering= stocks issued by a formerly private owned company that is going public

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26
Q

What is a seasoned equity offering?

A

Stocks offered by company that already have floated equity

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27
Q

Underwriters are

A

Investment bankers that market the stocks and bonds in a public offering

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28
Q

What is a underwriting syndicate?

A

Group of IB that share the responsibility for the stock issue. This syndicate is form by the lead underwriter

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29
Q

In a public offering, what is a red herring

A

Preliminary registration statement filed with the SEC that describes the issue and the prospects of the company..

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30
Q

Why the preliminary prospectus filed with the SEC receive the name of red herring

A

It always has a statement printed in red, stating that the company is not attempting to sell the security before the registration is approved

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31
Q

What a (final)prospectus contains?

A

Number of stocks, type of stocks and price per stock. and final background information of the company. It must be approved by the SEC

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32
Q

Who sells the securities to the public?

A

Investment bankers buy the securities to the issuing firm and resell them to the public

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33
Q

What is a firm commitment?

A

Price at which IB buys securities = Public offering price - spread (compensation) to the underwriters.

34
Q

What is shelf registration?

A

Allow firms to register securities and gradually sell them to the public for 2 years following the initial registrtion

35
Q

What are the advantages and disadvantages of a private placement?

A

Ad: cheaper, don´t need to prepare extensive and costly registration statements
Dis: not suited for very large offering
Do not trade in the secondary market = less liquid and may lower prices

36
Q

What is the purpose of the roadshows?

A
  1. Generate interest and provide information to potential investors
  2. Info about the potential price (willingness to pay)
37
Q

What is book-bulding?

A

Books= indication of interest (quantity and price range) on buying the IPO from large investors. Bookbuilidng= pool potential investors books

38
Q

Why an investor will reveal its real willingness to pay during book-building?

A

Shares of IPOs are allocated across investors in part based on the strength of each investor´s expressed interest in the offering

39
Q

Why IPOs are commonly underpriced?

A

The underwriter needs to offer the security at a bargain price to interested large investors to induce them to participate in book-building and share their information (on the market demand for the security, prospects of the firm and its competitors)

40
Q

What are the costs of an IPO?

A
  1. Around 7% of the funds raised

2. Underpricing of the security

41
Q

How are prices commonly named?

A

Buy prices= bid prices
Sell prices= ask prices
bid-ask spread =buy - sell price

42
Q

What is an observable trend with IPO´s?

A

After 5 years they have lower returns than privately held companies= IPO underperforming. Returns follow an inverted U pattern between yr 1 and yr5

43
Q

What is the winners curse?

A

Uninformed investors that assign a higher value than the intrinsic value of a stock in IPOs

44
Q

What are the two types of markets

A

Money markets= short term, low risk debt securities. Cash equivalents (named cash)= T- bonds
Capital Markets= long term (> 1 year) and riskier securities

45
Q

Who are flow traders?

A

Traders that trade with clients money vs. proprietary trading (firm money)

46
Q

What is the difference between a Passive Asset Management and an active asset management?

A 
Passive= copy a benchmark index SP&500, charge lower fees (0.5%). Believe in the market efficient market hypothesis
Active= higher commissions 3%, try to beat the market,  and are rated every 3 months (incentive to short term investments)
47
Q

Describe how short selling works if the current market price is 5 and you expect it to decrease to 4

A
  1. Borrow 100 stocks from you asset management firm (has inventory of the stocks) and sell it at market price 50. Rev =500
  2. Price decrease to 4. Buy 100 stocks in the market at cost = 400
  3. Return the 100 stocks to your brokerage making a profit of 500-400 = 100
    The risk is if the price don´t go down
48
Q

A beauty parade is

A

A firm looking to do an IPO that visits different IB

49
Q

A greenshoe option is

A

When demand for an IPO is higher than expected, the IB can sell more stocks (up to 15%) than originally planned

50
Q

What are the 3 secondary markets?

A
  1. National and Local Security Exchange
  2. OTC
  3. Direct trading between 2 parties
51
Q

What is fundamental analysis?

A

Forecast the expected earnings and dividends&raquo_space;> stock price of a company. Macro can explain 60-70% of a stock performance

52
Q

Top down investors believe that…

Who is a famous top down investor

A

To decide on investments we should focus on
Macro» Industry&raquo_space; Company
George Sorrow

53
Q

What is World GDP and how is roughly generated by countries

A

Total 77 trillion
US 25%
Europe 25%
China, Russia and Japan 25%

54
Q

What is demand shocks and some examples

A

Event that affects demand for goods and services in the economy

55
Q

What are demand shocks and some examples of positive demand shocks

A 
Event that affects demand for goods and services in the economy.  
Reduction in tax rates
Increases in the money supply
Increases in government spending
Increases in foreign export demand
56
Q

What is a supply shocks and examples

A

Event that influences production capacity and costs
Changes in price of imported oil, freezes, floods, draughts
Changes in the educational level of an economy´s workfore
Changes in the wage trate at which the labor force is willing to work

57
Q

During a demand shock the aggregate output is

A

Moving in the same direction as interest rates and inflation.

58
Q

During a demand shock the aggregate output moves in which direction?

A

Moves in the same direction as interest rates and inflation.

59
Q

Describe the posible consequences of an increase in government expending (positive demand shock) over other macroeconomic variables

A

> government expending > higher GDP
demand for borrowed funds > higher interest rates
demand of goods and services > total productive capacity of the economy > higher inflation

60
Q

During a supply shock the aggregate output moves in which direction

A

Moves in the opposite direction as interest rates and inflation

61
Q

If the price of imported oil increase, describe the possible impact on other macroeconomic variables

A

> production costs = > prices of final goods= > inflation

> inflation = > nominal interest rates = aggregate output falls

62
Q

What are the short and long term effects of monetary policy

A

Short term: + money supply - short term interest rates
+ investment and demand
Long term: + demand = + prices = - unemployment but - spending
= Not a permanent effect on economic activity

63
Q

What is monetary policy

A

Manipulation of the money supply to affect the macroeconomy

64
Q

Pros/cons of monetary and fiscal policy

A

Fiscal : + immediate effect on the economy - difficult to implement (political process)
Monetary: + easy to implement - short term effect

65
Q

What are the 3 tools used by the FED to implement monetary policy

A
  1. Open market operations= buy/sell short term T bonds (most common)
  2. Discount rate= interest rate it charges banks on short-term loans. (less frequent)
  3. Reserve requirements= fraction of deposits that banks must hold as cash or as deposits with the Fed
66
Q

What is the federal funds rate

A

Interest rate at which banks make short-term (overnight) loans to each other. The Fed targets federal funds rate using the money supply

67
Q

How an increase in money supply affects the interest rates

A

Increase quantity of money > more cash in portfolio > balance by buying securities > increase in bond prices
> decrease in interest rates

68
Q

What is Quantitative Easing

A

QE = flood the economy with money= Central bank buys short (3 months) and long term (10 years) T bonds. It bought in massive amounts using a schedule

69
Q

When USA/Europe used QE

A

USA: Q1 2007-2008
Q2: 2010 Q3: 2015 Total= USD4.5 trillion
Europe only started with QE in 2015

70
Q

What the critics of QE said about its efficiency

A

Fed gave $ to the banks but it never reached the consumers for 2 reasons:

  • Higher K requirements after the crisis
  • Tighter bank regulation on lending
71
Q

Why Europe only implemented QE in 2015

A
  1. Difficult to implement = buy bonds from different countries, there is not a European equivalent to the T bonds
  2. Banks were not sound enough. They had to pass an asset quality test
72
Q

What is a cyclical (defensive) industry and some examples

A

Cyclical: Above-average sensitivity to the state of the economy. Ex: Durable goods (as automobiles) and capital goods (goods used by other firms to produce their own products)
Defensive = little sensitivity to business cycle. Ex: food producers, pharmaceutical and public utilities

73
Q

What are the 3 economic indicators

A
  1. Leading= rise/fall before the GDP (stock market, moeny supply, new manufacturer orders, new contracts on PPE, initial claims for unemployment
  2. Coincident
  3. Lagging
74
Q

What is an ETF

A

TF trades like a stock on a stock exchange and looks like a mutual fund. Its performance tracks an underlying index, which the ETF is designed to replicate (passive asset management)

75
Q

What are the two categories of valuation methods

A
  1. Absolute: find the intrinsic or “true” value of an investment based only on fundamentals (value investment)
  2. Relative: compare the company to similar competitors: calculate ratios (price-to-earnings) and compare
76
Q

What is fundamental analysis

A
  1. Quantitative Analysis of BS, P&L and CF´s last 5 years
  2. Qualitative Analysis: team members, competitors, industry outline
    Warren Buffet used this method
77
Q

What are the types of absolute valuation methods

A
  1. Dividend discount model (DDM)
  2. Discounted cash flow model (DCF)
  3. Residual income models
  4. Asset-based models
78
Q

What is the Dividend discount model and when it is most useful

A

DDM= company must pay dividends + dividends must be predictable = Blue chip companies
No grow Value today/Price = Dividend/r
Grow in dividends Value = Dividends/r-g

79
Q

What is de DCF model and when it is most useful

A

Uses a firm’s discounted future cash flows to value the business. Company must have predictable + positive free cash flows
Price = Discounted cashflows (5 -10 years) + Terminal value (account for all the cash flows beyond the forecast period)

80
Q

When DCF model is not useful

A

Many small high-growth firms and non-mature firms will be excluded due to the large capital expenditures these companies generally face.

IESE MBA Term 1 (3 decks)

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