Equities Flashcards
What are the two capital structures in a corporation?
1) Risk Capital (equity, ordinary shares)
2) Debt, borrowings
Which of the capital structures is last in line if the company winds up?
1) Risk Capital
hence the name
What rights does an ordinary share get?
1) Right to dividend
2) Right to vote
Lowers priority for dividends & wind up capital
Key points on preference shares
- Receive a fixed payment (twice yearly)
- Rarely have the right to vote
- Only paid when company has the profit to do so
- (can have the right to vote if dividends fall into arrears)
What is the gordon growth model formula?
When a company gets large enough what might it seek to do?
IPO
Can list on main market
alternate market
or overseas
What is a depository receipt
An instrument created by a
- Represents shares in a foreign company
- allows it to trade like a domestic stock
- e.g. Dividend and price in USD
- no FX / cross border hassle
How does investment theory price a share?
NPV of all future cash flows
What is one flaw in the Gordon Growth model?
Assumes the company pays a dividend
e.g. Microsoft and Apple didn’t
What types of companies are more likely to pay dividends?
More mature companies
Smaller companies have to reinvest in themselves
What is the M&M theory
Payout via growth / dividend is irrelevant
Price is based on a companies ability to grow & increase profits
What assumptions does the M&M theory make?
1) No Taxes
2) No transaction costs
3) Leverage has no impact on WACC
What is liquidity dependant on in equity markets?
Division of Opinion
Liquidity is a determinent of share price
What does a near consensus opinion cause in equity markets
Liquidity Evaporates
What is the most popular framework for equity markets?
Electronic Orderbook
Give an example of a market which does not use an electronic market book:
London Metal Exchange (LME)
What are 8 pieces of information that influence share price?
1) Firm Specific Factors (Profit / Growth Outlook)
2) Macro (Cycle, interest rates etc.)
3) Legal Issues
4) Government Policy (Fiscal / Monetary)
5) Other Stock Markets
6) Geopolitcal Risks (Trade, War & Terrorism)
7) Economic Surveys (e.g. PMI)
8) Board Membership
What does consistent dividend growth signal to the market?
What is the effect of a change in dividend?
Solidity in the company
Unsettles the market, can lead to a sell-off. E.g. COVID
Some companies / industries are more affected by the wider market. Give an example:
Housebuilders
- Struggle with high interest Rates
Points about markets being correlated:
- Globalisation has caused a convergence in performance
- Western equities highly correlated
- US 0.98 to MSCI World
- In BRIC and Emerging countries, the correlation to the west is far lower.
How can behavioural factors influence share price.
- Disposition Effect
- Net buyers of attention grabbing stocks
- Buy prices rises
- Sell falls (& bad news)
There is no rational reasoning behind these.
Who create classifications for equity fund types?
The investment association (IA)
What is UK All Companies?
(IA)
Invests at least 80% in UK equities
(objective of capital growth)
What is APAC ex-Japan
IA
80% in APAC
Max 5% in Japan
What is Global Equity Income?
IA
80% Equities (diversified geographically)
(Yield of >100% of MSCI world)
100% on 3yr rolling & 90% of annual basis
What correlation helps reduce concentrated losses?
Low or Negative
What are the risks of equity?
- Volatile
- No guarentee of Dividend
- Capital at risk
- Risk of dillution
- Not a large enough shareholder to have a meaningful voice
- Rank last in liquidation
What are the benefits of equity investing?
- Potentially unlimited gain
- Dividend payment
- Voting Right
- Best returning asset class
- Higher liquidity
What does Beta show?
The correlation of the return on an qeuity to a return on the market.
What do these Beta’s show:
1) B=1
2) B=2
3) B=0.5
4) B=0
5) B=-1
1) Moves in line
2) Moves Wider
3) Moves less wide
4) Doesn’t move with market
5) Inverse
What is the most common way equities are traded?
Through a broker
What are the two types of brokerage service:
Discretionary
Non-Discretionary
What is discretionary brokerage?
The broker has discretion to execute trades without client input
(within defined perameters)
What are the two types of non-Discretionary brokerage?
1) Advisory - Client has final say but receives advice
2) XO - Broker carries out client instructions (no advice)
What are brokers expected to consider at all times?
The appropriateness of the service based on client circumstances
What is algorithm trading?
Using computers to buy or sell securities under a set of instructions (e.g. price, size, time etc.)
What problem was algorithm trading introduced to solve?
A fund place a large trade
1) Other firms front run
2) Risk is placed onto original firm
3) agile traders could position themselves to unduly benefit
How did algorithm trading solve the issue of front running?
Algorithms can seek out pools of liquidity.
Larger trades are now fragmented and executed over time at the optimal price
How has fragmentation of trades negatively effected equity trading?
Order books are less transparent as it is unclear if a trade is small or part of a larger trade.
It has also led to the development and use dark pools.
Why have MAR laws been introduced re: Algo Trading
Algorithm trading has been blamed for flash crashes due to the volatility it can cause.
GBP/USD fell 9% for 40 seconds due to algos
What are the three forms of market efficiency
1) Weak Form
2) Semi-Strong
3) Strong
What does weak form EMH say?
Current asset prices reflect historic market information
What does semi-strong form EMH say?
Prices reflect all publicly available information
What does strong form EMH say?
Prices reflect all information, both public and private.
Would argue that excess alpha is impossible to consistetly generate.
What does random walk theory claim?
Share price movements cannot be predicted based on historic movements.
Only new information can influecne the price of a share, and this itself is random.
What two observable effects can argue against the random walk theory?
1) Monday Effect
2) January Effect - highest price rises at beginning of year
January effect - potentially a result of end of tax year in the US.
What is the underpinning notion of behavioural finance?
Investors are not rational.
They exhibit cognitive biases
What is loss aversion and how can it be overcome?
Loss aversion is the belief that given an equal gain or loss. The emotion from a loss is more significant. This causes individuals to hold onto their stocks for too long.
Don’t get emotionally attached to investments
What is Overconfidence Bias?
How can it be overcome?
Too much belief in personal abilities - leads to overtrading
To avoid this, trade less, invest more.
What is anchoring?
Setting an initial value as a refernce point and not moving it.
What is herd bias?
The tendency to follow / copy others investments / behaviours as it is popular
Two types of stock tip reports:
1) Press Recommendations
2) Analyst / Broker Recommendations
How do stock tip / recommendations received by the market?
Prices can increase or fall due to reports. However, in some cases the fall can be coincidental.
How do speculators operate in the equity market?
1) Short term view
2) Long or short for quick profit
3) Can naked short sell
4) Can be susceptible to short squeezes
How do takeovers / M&A affect share price?
Acquirer has to pay premium which drives up the target share price.
Acquirer won’t see share price move up so often.
What 3 other factors influence share price?
1) Index membership
2) Programme Trading
3) Corporate Actions
What is equity crowdfunding?
Give 3 examples of platforms:
Allows investment for a stake in the business, value rises or falls with the success of the project.
1) Seedrs
2) Crowdcube
3) Yielders (Sharia Compliant)
Seedrs have introduced a secondary market that enables the trading of shares in unlisted companies on a secondary market.
