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Personal Finance > Chapter 11 - Investing in Stocks > Flashcards

Chapter 11 - Investing in Stocks Flashcards

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1
Q

Stock exchanges

A
  • facilities that allow investors to purchase or sell existing stocks.
  • Facilitate trading in the secondary market.
  • A stock must be listed on a stock exchange in order to be traded there.
  • To be listed on the TSX, a firm must meet minimum listing requirements in areas such as:
    –> Revenue, cash flow, net tangible assets, working capital, and cash.
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2
Q

Stock Exchange Markets

A

Canadian stocks are traded on two markets:

Toronto Stock Exchange (TSX)
-Where senior equities are traded.
TSX Venture Exchange
-Serves the public venture capital market.
—Venture capital: investors’ funds destined for risky, generally new businesses with tremendous growth potential.

Montreal Exchange
-Derivatives exchange (options and futures)

All of these are owned by one group: TMX

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3
Q

OTC Stock Exchanges

A

Over-the-counter (OTC) market: an electronic communications network that allows investors to buy or sell securities.

  • Not transparent- trade information is often compiled at the end of the day, not as it occurs.
  • Driven more by supply and demand than organized stock exchanges.
  • Business is transacted with one person, principal to principal, at their price and their price alone (in contrast to ‘the best price at the time’ on an organized exchange).
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4
Q

Stock Exchanges - Electronic Trading

A

-Electronic Trading
-Has eliminated the open-outcry system. (trading approach generally employed on a pit for stock, option, & futures exchanges. It entails the usage of oral & gestural signs by traders to convey trading details, intentions, & acceptance. )

futures: a type of derivative contract agreement to buy or sell a specific commodity asset or security at a set future date for a set price

-Bid price: the price at which a buyer would like to purchase a stock.
-Ask price: the price at which a seller would like to sell a stock.

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5
Q

Characteristics of High Quality Stock Exchanges - Electronic Trading

A

-Small difference between the bid price and the ask price (the bid-ask spread).
-Market liquidity
–>A large volume of shares being offered for purchase or sale with each trade request.
-Market depth
–>A large volume of traders making these requests.

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6
Q

Electronic Trading - Market makers

A

Market makers: securities dealers who are required to trade actively in the market so that liquidity is maintained when natural market forces cannot provide sufficient liquidity.

Liquidity of an electronic trading system is enhanced by market makers.

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7
Q

New York Stock Exchange

A

-Most popular organized exchange in the United States.
-Operates as a division of the Intercontinental Exchange (ICE) which also owns and operates Euronext which combines a number of European Exchanges.
-Rapid consolidation in global capital markets.

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8
Q

Stock Quotations

A

Where can you find stock quotes?
-Online (most up-to-date)
-Stockbrokers
-Financial newspapers (e.g. National Post, The Globe and Mail)
-Business sections of local newspapers
-Financial news television networks (e.g. BNN)
-Financial websites

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9
Q

Types of Brokerage Firms

A

Discount brokerage firm: a brokerage firm that executes transactions but does not offer investment advice.

Full-service brokerage firm: A brokerage firm that offers investment advice and executes transactions.
Tend to charge higher fees for their services than discount brokers.

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10
Q

Purchasing or Selling Stocks - Placing an order

A

Name and class of the stock
-Know the ticker symbol
-Ticker symbol: the abbreviated term used to identify a stock for trading purposes

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11
Q

Purchasing or Selling Stocks - Number of Shares

A

Number of shares

Board lot: shares bought or sold in multiples of typically 100 shares. The size of the lot depends on the price of the security.

Odd lot: less than a board lot of that particular stock.

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12
Q

Purchasing or Selling Stocks - Market order or limit order

A

Market order: an order to buy or sell a stock at its prevailing market price.
-Your order will be executed.
-Stock price could abruptly change.

Limit order: an order to buy or sell a stock only if the price is within limits that you specify.
-Can be for one day only or valid until cancelled.

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13
Q

Purchasing or Selling Stocks - Buying stock on margin

A
  • Margin: the amount of your own cash that you must use to purchase stock.
  • Magnifies gains and losses.
  • Investment Industry Regulatory Organization of Canada (IIROC) limits the maximum amount that can be borrowed for a TSX listed stock.
    -Margin call: a request from a brokerage firm for the investor to increase the cash in their account in order to return the margin to the minimum level.

Refer to Slide 19 for example

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14
Q

Purchasing or Selling Stocks - Short selling stock

A

Short selling (or shorting): the process by which investors sell a stock that they do not own.

-Stock is overvalued (sell high, buy low).
-Borrow the stock from the brokerage firm.
-Purchase the stock at a future point in time.
-IIROC sets limits on the amount of margin that is required when short selling a TSX listed stock.

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15
Q

General - Analyzing a Firm’s Financial Condition

A

Among other things, annual report contains
-Corporate profile
-Message from the CEO
-Section summarizing recent performance and expected future performance.
-Financial statements

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16
Q

Analyzing a Firm’s Financial Condition - Balance Sheet

A

-Balance sheet: a financial statement that indicates a firm’s sources of funds and how it has invested its funds as of a particular point in time.
-Assets indicate how the firm has invested its funds and what it owns.
-Liabilities and shareholder’s equity indicate how the firm has obtained its funds.

Assets = Liabilities + Shareholder’s Equity

17
Q

Analyzing a Firm’s Financial Condition - Income Statement

A

Income statement: a financial statement that measures a firm’s revenues, expenses, and earnings over a particular period of time.

Annual report may include an income statement for the year of concern and for the four quarters within that year.

18
Q

Firm-Specific Characteristics - Liquidity

A

Current ratio: the ratio of a firm’s current assets to its current liabilities.
-Current ratio of 2.0 or higher is considered a reasonable level of liquidity for most industries.

Quick ratio: the ratio of a firm’s current assets, less inventory, to its current liabilities.
-Quick ratio of 1.0 or higher is considered a reasonable level of liquidity for most industries.

19
Q

Firm-Specific Characteristics - Efficiency

A
  • How efficiently a firm uses its funds to generate sales.
  • Accounts receivable turnover: the frequency with which a firm can collect its accounts receivables.
  • Inventory turnover: cost of goods sold divided by average daily inventory.
  • Total asset turnover: sales divided by average total assets.
20
Q

Firm Specific Characteristics - Financial Leverage

A

The ability to make debt payments.
Indicates a firm’s reliance on debt to support its operations.

Debt-equity ratio: measures the relative amount of funds provided by lenders and owners.

Times interest earned/interest coverage ratio: the ratio of the firm’s earnings before interest and taxes to its total interest payments.

21
Q

Firm-Specific Characteristics - Profitability

A
  • Net profit margin: net profit as a percentage of sales.
  • Return on assets: net profit divided by total assets.
  • Return on equity: net profit divided by the owners’ investment in the firm (shareholder’s equity).
22
Q

Economic Analysis of Stocks - Economic Growth

A

Economic growth: the growth in a country’s economy over a particular period.
-Commonly measured by GDP.
–Gross domestic product (GDP): the total market value of all products and services produced in the country.
–>Closely related to the aggregate (overall) demand for products and services.

23
Q

Economic Analysis of Stocks - Interest Rates

A
  • Fiscal policy: how the government taxes on individuals and corporations and how it spends tax revenues.
  • Closely linked to the need to grow an economy, create jobs, and provide services.
  • Interest Rates
    When rate are low:
    ->Stocks generally perform better.
    ->Firms tend to be more willing to expand.
    ->Enables more consumers to afford cars or homes.
24
Q

Economic Analysis of Stocks - Inflation

A

Monetary policy: techniques used by the Bank of Canada to affect the economy of the country by influencing interest rates.

Inflation: the increase in the general level of prices of products and services over a specified period.
-> Consumer price index (CPI): a measure of inflation that represents the increase in the prices of consumer products such as groceries, household products, housing, and gasoline over time.

25
Q

Industry Analysis of Stocks

A

Demand for products or services within an industry changes over time.

Competition also affects sales, earnings, and stock prices.

26
Q

Stock Valuation - Inefficient/Efficient Stock Market

A

Efficient stock market: a market in which stock prices fully reflect information that is available to investors.

Inefficient stock market: a market in which stock prices do not reflect all public information that is available to investors.

An efficient stock market implies that you will not be able to identify stocks that are undervalued.

27
Q

Stock Valuation - Dividend discount model (DDM)

A
  • a method of valuing stocks in which a firm’s future dividend payments are discounted at an appropriate rate of interest.
    -> Works best for mature firms that pay a large stable dividend.
    -> Three common versions:
    —Zero-growth model
    —Constant-growth model
    —Variable-growth model
28
Q

Stock Valuation - Price-earnings (P/E) method

A

Price-earnings (P/E) method
- Used to determine the value of a stock based on the value of the firm’s earnings.

  • High P/E ratio:
    –>Firm is either overvalued relative to comparable companies and/or an industry benchmark, or
    –>Firm has higher growth prospects relative to comparable companies and/or an industry benchmark.

-Appropriate to calculate and compare many valuation models when valuing stocks.

Personal Finance (6 decks)

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