Cheat Sheet Equity Investments

Question 1

Execution instructions types for orders

Market orders

Answer 1

Order is immediately executed at best price available.

Question 2

Execution instructions types for orders

Limit orders

Answer 2

Sets a minimum price for sell orders, or a maximum price for buy orders.

However, order may not be executed at all if markets are fast moving or there are insufficient liquidity.

Question 3

Execution instructions types for orders

All-or-nothing orders

Answer 3

Order will only be executed if the entire quantity can be traded.

Question 4

Execution instructions types for orders

Hidden orders

Answer 4

Large orders that are only known to brokers/exchanges that are executing them, until the trades are executed.

Question 5

Execution instructions types for orders

Iceberg orders

Answer 5

A small % of a large hidden order is executed first to gauge market liquidity, before the entire order is executed.

Question 6

Market order vs limit order

Arten von Limit Orders

Answer 6

Arten von Limit Orders:

a) Marketable (aggressively priced):
Diese Limit Orders sind so gesetzt, dass sie sofort ausgeführt werden können, da sie den aktuellen Marktpreis über- oder unterschreiten.

Eine limitierte Kauforder, die über dem besten Angebotspreis (best ask) liegt, wird sofort ausgeführt, da sie bereit ist, mehr zu zahlen als der aktuelle Verkäufer verlangt. Eine limitierte Verkaufsorder, die unter dem besten Gebotspreis (best bid) liegt, wird sofort ausgeführt, da sie bereit ist, weniger zu akzeptieren als der aktuelle Käufer bietet.

b) Making a new market / inside the market:
Diese Limit Orders werden zwischen dem besten Gebotspreis und dem besten Angebotspreis platziert. Sie schaffen neue Preisniveaus innerhalb des bestehenden Marktes.

Der Limitpreis liegt über dem besten Gebotspreis, aber unter dem besten Angebotspreis.

c) Behind the market:
Diese Limit Orders sind so gesetzt, dass sie nicht sofort ausgeführt werden, da sie außerhalb des aktuellen Marktpreises liegen.

Eine limitierte Kauforder, die unter dem besten Gebotspreis liegt, wird nicht sofort ausgeführt, da sie weniger bietet als der aktuelle Käufer bereit ist zu zahlen. Eine limitierte Verkaufsorder, die über dem besten Angebotspreis liegt, wird nicht sofort ausgeführt, da sie mehr verlangt als der aktuelle Verkäufer bereit ist zu akzeptieren.

Question 7

Validity instructions types

Day orders

Answer 7

Orders that expire if unexecuted by end of day it is submitted.

Question 8

Validity instructions types

Good-till-cancelled orders

Answer 8

Orders that last until the buy or sell order is executed.

Question 9

Validity instructions types

Immediate or cancel orders (“fill or kill”)

Answer 9

As per its name, once the order is submitted it has to be immediately executed. If it is not executable immediately, the order is cancelled.

Question 10

Validity instructions types

Good-on-close (market-on-close)

Answer 10

Order is only executed at the close of trading.

Question 11

Validity instructions types

Stop orders (stop-loss)

Answer 11

Orders that come with a trigger price, designed to limit losses.

E.g. stop-sell orders will execute if price is at or below stop/trigger price. Whereas, stop-buy orders will execute if price is at or above stop/trigger price.

Question 12

Forms of market efficiency and its implications

Weak-form

Question 13

Forms of market efficiency and its implications

Semi-strong form

Question 14

Forms of market efficiency and its implications

Strong form

Question 15

Behavioral finance

Loss aversion

Answer 15

Individuals dislike losses more than the gains of the same amount.

Question 16

Behavioral finance

Herding

Answer 16

Investors follow what other investors are doing and ignores own private information.

Question 17

Behavioral finance

Overconfidence

Answer 17

Placing too much confidence in ability to predict.

Question 18

Behavioral finance

Information cascades

Answer 18

An individual copies the trades of other market participants who acted first. Related to herding.

Question 19

Behavioral finance

Representatitveness

Answer 19

Investors base expectations upon past experience, applying stereotypes. If-then heuristic (when investor bases expectations of future on some past/current characteristics. e.g. if A happens, then B will happen)

Question 20

Behavioral finance

Mental accounting

Answer 20

Keeps track of individual investment’s gains and losses separately, rather than view them as a total portfolio overall.

Question 21

Behavioral finance

Conservatism

Answer 21

Unwilling to radically readjust from original analysis (often heuristic & much less accurate), only adjusting directionally.
Hence inability to fully incorporate impact of new information on projections and react slowly.

Question 22

Behavioral finance

Narrow framing

Answer 22

Investors focus on issues in isolation.

Question 23

Risk of equity securities

Preference shares have lower risk than common shares because:

Answer 23

• preferred dividends are fixed and they form a larger portion of total return in case of preference shares
• preference shares rank above common shares in their claim on earnings and net assets (in the event of liquidation)

Question 24

Risk of equity securities

Putable shares

Answer 24

Putable shares have a lower risk than callable or non-callable shares because they can be sold back to the issuer if the stock price falls below a threshold. Hence putable shares have lower dividends.

Question 25

Risk of equity securities

Callable common and preference shares

Answer 25

Callable common and preference shares are more risky than their non-callable equivalents because the issuer can buy back the shares at a pre-determined price. Similarly, cumulative shares have a lower risk (and hence lower dividends) than non-cumulative shares as they accrue unpaid dividends.

Question 26

Porter’s five forces

Answer 26

• Threat of substitutes
• Customer’s bargaining power
• Supplier’s bargaining power
• Threat of new entrants
• Intensity of rivalry among existing competitors

Question 27

PESTLE framework

Answer 27

• Political influences
• Economic influences
• Social influences
• Technological influences
• Legal influences
• Environmental influences

Question 28

Industry lifecycle model

Answer 28

Embryonic
Slow growth, high prices, high failure risk, significant investment required.

Growth
Rapidly increasing demand, improved profitability, lower prices, relatively low competition.

Shakeout
Slowing growth, intense competition, focus on cost reduction, declining profitability, some failures/mergers.

Mature
Little or no growth, industry consolidation, high barriers to entry, strong cashflows.

Decline
Negative growth, excess capacity, high competition, weaker firms exit.

Question 29

Dividend payment chronology

Answer 29

Declaration date:
Company declares the dividend

Ex-dividend date:
Cutoff date on or after which buyers of a stock are not eligible for the dividend. Also the first date where the stock trades without dividend.

Holder-of-record date:
A record of shareholders who are eligible to receive dividend is made, usually 2 days after ex-dividend date.

Payment date:
dividend payment made to shareholders

Question 30

Types of equity valuation models

Answer 30

Present value models:
Estimate value as present value of expected future benefits, e.g. dividend discount models, free cash flow to equity models

Multiplier models:
Estimate intrinsic value based on multiple of some fundamental variable. E.g. price to earnings, price to book value, enterprise value (EV) to EBITDA ratios.

Asset-based valuation models:
Estimate value of equity as fair value of assets less fair value of liabilities.

Question 31

Enterprise value

Answer 31

Enterprise value is an alternate measure for equity which measures the market value of a firm’s debt and equity. It can be viewed as the cost of taking over a company.

EV = Market value of debt + Market value of equity + Market value of preferred stock – cash and short term investments

EV/EBITDA multiple is useful for comparing companies with different capital structures, to evaluate the cost of a takeover and for analyzing loss making companies.

That said, a limitation of EV method is that market value of debt can be hard to estimate.