Equity Flashcards
Long Position
Buy
Utilized when you think the stock price will increase (appreciate)
You’re in the position for the long game, you believe holding this share will appreciate over time
If the stock price decreases, sell limit orders are place so that you’re share price doesn’t go any lower than you’re comfortable with
Short Position
Sell
Hoping to profit from a decline in stock prices, to sell back your shares at an exercise price that is greater than the market
Instructs the broker to execute the trade immediately at the best possible price
Market Order
-guaranteed execution
-no guaranteed price
Market orders gaurantee:
Limit orders gaurantee:
Market orders gaurantee execution (not price)
Limit orders gauranteed price (not execution)
This type of execution instruction is used when lack of liquidity is a concern
Limit orders
Places a minimum execution price on sell order and a maximum execution price on buy orders
Limit orders
-no guaranteed execution
-guaranteed price
An investor sold a stock short and is worried about rising prices. To protect himself from rising prices he would place a:
Stop buy order
(Validity Instruction)
This limits the short seller from infinite losses, by setting a ceiling on the price, so that you don’t have to buy back your borrowed shares at a price that would incur significant losses
The amount of equity that is initially required to purchase security on margin
initial margin
buy order: limit price < best bid
sell order: limit price > best ask
behind the market; an order to buy for less than the market price or sell for more than the market price
Orders with limit prices between the best bid and best ask
inside the market
buy order: limit price > best ask
sell order: limit price < best bid
aggressively price; an order that is willing to pay more or sell for less
In a call market, a stock would trade at:
One negotiated price that clears the market
Call market: stocks trade at specific times
An order placed below the market price to execute at a certain price to protect the investor from further decline:
Stop loss sell; executed when the share price drops
Validity Instruction
Validity Instruction used to protect gains on a long position & minimize losses
stop loss sell
When you go long a stock, you expect the stock price to appreciate over time, but if the share price decreases, you can minimize losses by engaging in a stop loss sell order that will place a floor at the lowest price you are comfortable with selling at
An order to buy if a price increases to a specified level
An order that is above the current market price & would be executed when the market price increased to the specified stop price
Stop buy order; minimizes the short-sellers losses if the stock price increases
Validity Instruction
A securities market exhibits operational efficiency if it offers:
low transaction costs
Operational efficiency contributes to informational efficiency
prices do not adjust much from one transaction to the next, unless new information about firm value becomes available
price continuity
When capital is being directed to its most productive uses, the market is said to be:
Allocationally efficient
an order that is placed between the best bid and best ask is termed to be a?
making a new market
The best market structure for unique items
brokered markets;
A broker adds value by locating a counterparty to take the opposite side of a trade of such an item.
Indexes weighted on earnings, dividends, or book values
fundamental-weighted indexes
Compared to a market capitalization weighted index, a price weighted index produces:
Downward bias
Because firms that split their stocks decrease in weight within a price-weighted index
“Averages” Indexes
Index weights are based on the total value of shares available to the investing public, rather than all the outstanding shares of a firm
Float adjusted mark capitalization weighted index
Which type of index is most likely to be adjusted for free float
Market capitalization/value weighted index
i.e., Float adjusted Market capitalization index
invest heavily in stocks that have increased the most in value over the recent past
momentum strategy
The type of index weighting that produces a portfolio similar to that of a momentum strategy is:
Holding a portfolio that tracks the market (value) capitalization weighted index is similar to a momentum strategy
Because stocks with the best returns are given heavier weightings in this index
Adjusting the weights of constituent securities in an index to maintain consistency with the index’s weighting method
rebalancing
Used as proxies for measuring market or systematic risk, not as measures of systemic risk
Security market indexes
The difference between the return of the actively managed portfolio and the return of the passive portfolio:
Alpha
measure of risk adjusted return
measures the amount of systematic risk
beta
The basis for construction of nearly all bond market indexes
Dealer Prices
Firms (dealers) are assigned to specific securities and are responsible for creating liquid markets for those securities by purchasing and selling them from their inventory
require frequent reconstitution
Commodity index values are based on:
Futures contract prices
often require frequent reconstitution
In this type of index:
Constituents determine the index, rather than index providers determining the constituents
Hedge fund indexes
Hedge funds are not required to report their performance to any party other than their investors. Therefore, each hedge fund decides to which database(s) it will report its performance
Reflect the changes in future prices and the roll yield:
commodity index returns
Most hedge fund indexes are:
Equal weighted
Equity and fixed income indexes are predominately:
Market capitalization (value) weighted
Used as a proxy for the market return in a pricing model such as the CAPM.
Security market index
A securities market exhibits informational efficiency if :
- Prices change rapidly to reflect new information, without predictable bias
- Rates of return are proportional to risk
In a fundamental weighting method for stock indexes, there is a tilt to:
Value tilt
When using earnings as the fundamental to compare to MV, value stocks will have higher earnings and thus be overweight in the index
The type of equity index most likely to require rebalancing is:
Equal weighting
Since all securities positions are made equal, rebalancing is required frequently as prices change
A trader places a limit order to buy shares at a price of $49.94 with the stock trading at a market bid price of $49.49 and the bid–ask spread of 0.7%. The order will most likely be filled at:
An order is filled at the best available price as long as this price is lower than the limit price.
In this case, the best available price is the market ask price = $49.49 × (1 + 0.7%) = $49.84. Because this price is lower than the limit price of $49.94, the order will be filled at this price.
Seek out traders that are willing to take the opposite side of their client’s orders:
Brokers
A trader seeking to sell a very large block of stock for her client will most likely execute the trade in a(n):
Brokered market
A trading system that matches buyers and sellers based on price and time precedence is:
Order driven-markets:
Exchanges & automated trading systems
Pure auction market: Prices are set by sellers & buyers
Investors trade with dealers at bid and ask prices, set by the dealers:
Price/Quote-driven market
Over-the-Counter
Dealers buy securities from clients, with the expectation that they will be able to sell the securities to other clients in the future at higher prices.
Brokers organize trades amongst their clients
Brokered market
the firm must pay the holder any omitted dividends before it can pay any dividends to common shareholders
cumulative preference shares
Issued outside the issuer’s home country & denominated in dollars
Global depository receipts
Can be sponsored or unsponsored
When book values are not stable, analysts should calculate ROE based on the:
average book value for the unstable period
When book values are stable, analysts should calculate ROE based on the:
beginning BV for stable time period
A basket of listed depository receipts is best described as:
exchange traded fund (ETF) of Global depository receipts
Type of preference shares that receive extra dividends if firm profits exceed a predetermined threshold
Participating
Compared to preferred stock, common stocks is:
- Common stock is riskier than preferred stock
- Expected to provide higher average returns
The depository bank retains the voting rights of the equity shares of the foreign firm
Unsponsored Depository receipt
The foreign firm and the depository bank are not in collaboration
The type of equity depository receipt that gives its owners the right to vote and receive dividends from a company’s shares:
sponsored Depository Receipt
The foreign firm and the depository bank are in collaboration
identical common shares that trade in local currencies on stock exchanges around the world
global registered shares
If the currency is depreciating, investors from (inside or outside) the country will experience foreign exchange losses that decrease their returns?
outside the country (foreign investors investing in a depreciating currencies exchanges)
When a company issues debt to repurchase outstanding shares of equity, the ROE will:
increase; because it would decrease the denominator (less equity)
Sector rotation strategy times investments through analysis of:
Strategy that times investment in industries through an analysis of fundamentals and/or business-cycle conditions
Overweighting or underweighting industries based on the current phase of the business cycle
sector rotation strategy
Firms with high earnings volatility and high operating leverage, are considered:
cyclical firms
Addresses the sources of a portfolio’s returns, usually in relation to the portfolio’s benchmark
portfolio performance attribution
Industry analysis is most useful for:
portfolio performance attribution
Peer group construction involves:
- Identifying firms that derive their revenue and earnings from:
Identifying firms that derive their revenue and earnings from similar business activities
Usually start with the commercial classification and then group based on what the business activity is
Model shows how demand evolves over time as an industry passes from the embryonic stage through the stage of decline
Industry life-cycle model (time = x axis) (demand = y axis)
In a concentrated industry, industry members will avoid:
Since there are only a few firms, firms avoid price competition
Economic profit is earned and value is created for shareholders when the industry earns returns above the company’s:
Industry returns > Cost of capital
A company with successful cost leadership strategy is characterized by a:
low cost of capital
Offensive: used to gain market share (gain)
Defense: used to maintain market share (protect)
Provides a description of the company’s business, investment activities, governance, and strengths and weaknesses:
corporate profile
This model uses a single constant growth rate of dividends
Gordon growth model
The model that is best for valuing stable and mature, non-cyclical, dividend paying firms
Gordon growth model
For rapidly growing companies that expected to pay dividends that growth rapidly, slowing, or erratically over some period, and then become constant should use which model?
multistage growth model
Low price to earnings multiples signifies:
High future returns
Price to earnings multiples are used for predicting:
predicting stock returns
The EV/EBITDA ratio is most useful for when firms have:
- different capital structures or
- earnings are negative
EBITDA will still be positive, if earnings are negative
Asset based models are most useful for firms with:
- large portion of tangible assets
- readily available market values
In an asset based model, the value of equity is based on:
value of equity=
Fair value assets - Fair value liabilites
Book value?
Measure of a firm’s dividend paying capacity
Free cash flow to equity (discount model)
In the Gordon growth model, r must be
required return > growth rate
Growth companies transitioning to the mature stage would use which model?
2-stage DDM
Young companies entering the growth phase would use which model?
3-stage DDM
Valuation technique most approprite for valuing shares of a firm that does not pay dividends:
Free cash flow model
The total value of a firm’s outstanding equity shares based on market prices and reflects the expectations of investors on future performance
Market Value of equity
In this stage, an industry is characterized by:
* increasing profitability
* decreasing prices
* low degree of competition among competitors
* Rapid demand
Growth stage
In this stage, an industry is characterized by:
* Slower growth
* industry overcapacity
* intenense competition, price wars
* protitable, but declining
Shakeout phase
In this stage, an industry is characterized by:
* litte/no growth
* stable pricing
* industry consolidation
* high barriers to entry
* efficient cost structure
Mature phase
In this industry life cycle, firms are focused on extending product lines, rather than creating new ones; resulting in:
* Efficiency gains
* Increased market share with superior products
Mature phase
In this stage, an industry is characterized by:
* Negative growth
* Higher production costs, as demand falls
Decline stage
In this stage, an industry is characterized by:
* slow growth
* high prices
* high risk
Embryonic phase
When a company must raise equity capital to ensure it can continue to operate as a going concern, capital is most likely raised to:
- Improve capital adequacy ratios
- fulfill regulatory requirements
- ensure debt covenants are met
An increase in the dividend payout ratio will increase the:
An increase in the dividend payout ratio will increase the cash expected to be distributed to shareholders
The present value of the cash expected to be distributed to shareholders:
DDM
An increase in the dividend payout ratio will most likely increase the intrinsic value when using a(n):
Present value model (DDM)
An increase in the dividend payout ratio will increase the intrinsic value in a present value model
Refers to uninformed traders watching the actions of informed traders when making investment decisions
Information cascades
When trading occurs in clusters, not necessarily driven by market info
herding behavior
Investors viewing events in isolation
narrow framing
Exhibited by an investor who dislikes a loss more than he likes an equal gain.
That is, the investor’s risk preferences are asymmetric
Loss aversion
Refers to mentally classifying investments in separate accounts rather than considering them from a portfolio perspective
Mental accounting
Refers to a tendency to maintain one’s prior views even in the presence of new information.
Conservatism
This clearing instruction can prevent market prices from becoming overvalued:
short selling
A portfolio managers should use passive management because neither technical analysis nor fundamental analysis will generate positive abnormal returns on average over time, in which form of EMH?
Semi-strong efficient & Strong-form
Abnormal returns cannot be achieved from fundamental analysis
In an informationally efficient market:
An investor would use (active/passive) managed account:
Passively managed account
Active investment strategies will underperform over time; can’t consistently achieve superior risk-adjusted returns
The result of tax induced trading at year end;
An investor can profit by buying stocks in December and selling them during the first week in January.
The January Anomaly
Strong- form of EMH assumes:
Perfect markets in which all information is both:
Information is:
1. Cost free
2. Available to everyone
No group of investors has monopolistic access to information relevant to the formation of prices:
Strong-form EMH
Assumes that stock prices reflect all information: market, non-market, & private
Strong form
A momentum strategy suggests it is possible to earn abnormal returns using market data; providing evidence against:
weak & semi-strong forms
This pattern is attributed to:
Finding that firms with poor stock returns over the previous three or five years (losers) have better subsequent returns than firms that had high stock returns over the prior period
overreaction effect
Which form of EMH provides:
Investment strategies based on fundamental analysis of public information and past market data could achieve consistent positive risk-adjusted returns:
Weak-form efficient
This does not hold for technical analysis
- Security prices reflect publicly known and available information and past market data
- Stock prices instantly adjust to new public information
Semi-strong form efficient
Assumes the price of a security reflects all historical price and volume information:
Weak-form efficiency
Functions:
* To allow individuals and organizations to save, borrow, raise capital, and manage risks;
Productive uses:
* To determine equilibrium rates of return that equate the amounts of lending and borrowing; and to allocate capital
Financial System
What is a limitation to a fully efficient market?
Processing new information entails costs and takes at least some time
Time line of dividend payments:
D, E, H, P
Registration of shares is not required in which market:
Private placement, Primary market
The S&P 500 index is:
Market (value) capitalization weighted
- Rivalry among existing competitors.
- Threat of entry.
- Threat of substitutes.
- Power of buyers.
- Power of suppliers
Five Competitive Forces
(Porter’s 5 Forces)
In a market (value) capitalization weighted index:
- Successful stocks are:
- Poor performing stocks are:
- Successful stocks are given the greatest weights
- Poor performing stocks are underweighted
Stocks with higher capitalization have greater influence on the index performance
An information trader expects to earn a positive risk-adjsuted returns through:
Active management
An investor expects to earn:
equilibrium (fair) returns over time
Right to buy an asset:
Long call
Right to sell an asset:
Put options
Obligation to buy an asset:
short/write call
Rules of short selling:
- The short seller pays:
- Short seller deposits:
- The short seller pays the dividends to the lender
- Short seller deposits margin/collateral
Sell high & buy low applies to:
Short selling
Clearinghouses reduce & promote:
Reduce counterparty risk
promote market integrity
Cross sectional anomalies:
Value-effect says that these fundamentals will outperform:
- Low P/E
- Low market to book value
- High dividend yield
Characteristics of value stocks
Cross sectional anomalies:
Size effect says:
Small cap stocks outperform large cap stocks
Disadvanatges of direct investing in foreign equity:
- Denomination
- Less:
- regulations & procedures:
- Investment & return might be denominated in foreign currency
- Less liquid
- Less transparency
- Regulations & procedures might be different
When a stock has an intrinsic value greater than price, an investor should:
Buy the stock
When market value is greater than intrinsic value, there is strong demand for a stock & it is:
Overvalued
The price that investors with full knowledge of the asset’s characteristics would place on the asset:
Intrinsic/fundamental Value
In highly efficient markets, investors can expect market values to equal:
Intrinsic value
If a researcher finds statistically significant abnormal returns, does this imply market inefficient?
No; this is a market anomoly
Passive portfolio management should outperform actively managed, on a risk-adjusted basis in: (EMH)
Semi-strong efficient
Growth stocks:
* P/E
* Dividends
* market to book ratios
- High P/E
- Low Dividends
- High market to book ratios
EMH & Asset based models only require that markets behave:
Rationally
Analysis of public, non-market data:
Fundamental analysis
Industry weighting is performed by adjusting the industry weights in a portfolio baesd on:
the current stage of the business cycle
Thraet of new entry is greatest in which industry life cycle?
Growth
Book value of equity includes both:
Common & Preferred
Based on past performance
Market value of equity is affected by:
Investor’s expectation about the firm’s performance
Defensive stocks are less sensitive to economic cycles & have:
Beta
Systematic risk
Low beta
Low systematic risk
