Equity

Question 1

Long Position

Answer 1

A long position in an asset represents current or future ownership. A long position benefits when the asset increases in value.

Question 2

Short Position

Answer 2

A short position represents an agreement to sell or deliver an asset or results from borrowing an asset and selling it. A short position benefits when the asset decreases in value.

Question 3

Well-Functioning Security Markets

Answer 3

• Operational efficiency (lowest possible transactions costs).
• Informational efficiency (prices rapidly adjust to new information

Question 4

Leverage Factor (Leverage ratio)

Answer 4

Leverage Factor = 1 / Margin Percentage

Question 5

Leverage Return

Answer 5

Leverage Return = HPR X Leverage Ratio

Question 6

Margin Call Price

Answer 6

Maintenance margin % = [(Initial Margin % x P_initial + (P_margin - P_initial)] / P_margin

Question 7

Type of orders

Answer 7

• Execution instructions: how to trade; e.g., market orders, limit orders.
• Validity instructions: when to execute; e.g., stop orders, day orders, fill-or-kill orders.
• Clearing instructions: how to clear and settle; for sell orders, specify short sale or sale of owned security.

Question 8

Bid-ask spread

Answer 8

• The bid price is the price at which a dealer will buy a security.
• The ask or offer price is the price at which a dealer will sell a security.
• The difference between the bid and ask prices is referred to as the bid-ask spread and is the source of a dealer’s compensation.
• The bid and ask are quoted for specific trade sizes (bid size and ask size).
• The quotation in the market is the highest dealer bid and lowest dealer ask from among all dealers in a particular security.

Question 9

Price-weighted index

Answer 9

Price-weighted index = sum of stock prices / number of stocks in index

Number of stocks in index must be adjusted for stock splits

Most sensitive to stocks with the highest price

Question 10

Market capitalization-weighted index

Answer 10

current index value = (Current total market value of index stocks / base year total market value of index stocks) × base year index value

Most sensitive to stocks with the highest market capitalization

Question 11

Forms of EMH

Answer 11

• Weak form. Current stock prices fully reflect available security market info. Volume information/past price do not relate to future direction of security prices. Investor cannot achieve excess returns using tech analysis.
• Semi-strong form. Security prices instantly adjust to new public information. Investor cannot achieve excess returns using fundamental analysis.
• Strong form. Stock prices fully reflect all information from public and private sources. Assumes perfect markets in which all information is cost free and available to everyone at the same time. Even with inside info, investor cannot achieve excess returns.

Question 12

Industry life cycle stages

Answer 12

• Embryonic: slow growth, high prices, large investment needed, high risk of failure.
• Growth: rapid growth, falling prices, limited competition, increasing profitability.
• Shakeout: slower growth, intense competition, declining profitability, cost cutting, weaker firms fail or merge.
• Mature: slow growth, consolidation, stable prices, high barriers to entry.
• Decline: negative growth, declining prices, consolidation.

Question 13

Five Competitive Forces

Answer 13

1. Rivalry among existing competitors
2. Threat of entry
3. Threat of substitutes
4. Power of buyers
5. Power of suppliers

Question 14

Behavioral Finance

Answer 14

Disposition effect: behavioral bias in which investors tend to avoid realizing losses but, rather, seek to realize gains.

Conservatism: behavior of reacting slow to changes.

Loss aversion: Over-reacting, including a dislike for losses more than liking comparable gains.

Representativeness: A behavioral bias in which an investor assesses probabilities of outcomes depending on how similar they are to the current state is called

Narrow framing: Investors focus on issues in isolation .

Question 15

Trailing P/E ratio

Answer 15

Trailing P/E ration = Current stock price / Current earnings per share

Question 16

P/E ratio based on the Gordon growth dividend discount model

Answer 16

= (D1 / E1) / (r − g)

Question 17

Declaration date, ex-dividend date, record date, and payment date

Answer 17

• Declaration date. The date the board of directors approves payment of a dividend, specifying the per-share dividend amount, the date shareholders must own the stock to receive the dividend (record date), and the date the dividend payment will be made (payment date). Only occurs on business days. Determined by Corporation.
• Ex-dividend date. The first day on which a share purchaser will not receive the next dividend. The ex-dividend date is one or two business days before the holder-of-record date, depending on the settlement period for stock purchases. If you buy the share on or after the ex-dividend date, you will not receive the dividend. Only occurs on business days. Normally determined by the security exchange on which the shares are listed
• Holder-of-record date (record date). The date on which all owners of shares will receive the dividend payment on their shares. Only occurs on business days. Determined by Corporation.
• Payment date. The date dividend checks are mailed to, or payment is made electronically to, holders of record. Can occur on weekend or holiday.

Question 18

Cost of equity

Answer 18

A company’s cost of equity is often used as a proxy for the investor’s minimum required rate of return because it is the minimum expected rate of return that a company must offer its investors to purchase its shares in the primary market and to maintain its share price in the secondary market.

Question 19

Momentum Tilt and Value Tilt

Answer 19

• Momentum Tilt: Weight increase with stock price
• Value Tilt: Weight increase with earning yield

Question 20

Stop Order vs. Limit Order

Answer 20

• Stop Order: Minimize loss, validity instruction may be executed at a less preferable price if the next available price is much lower or much higher than the stop order
• Limit Order: Maximize gain, execution instruction, may not be filled

Question 21

Market Anomaly

Answer 21

An anomaly is something that deviates from the common rule. Tests of the EMH are frequently called anomaly studies, so in the efficient markets literature, a market anomaly is something that would lead us to reject the hypothesis of market efficiency.

Question 22

Contingent convertible bonds

Answer 22

Contingent convertible bonds automatically convert to equity if the issuer’s equity falls below the minimum percentage stipulated by regulators. Issuers are typically banks. Neither the issuer nor the bondholder has an option to convert the shares.

Question 23

Medium-term notes (MTNs)

Answer 23

• Custom debt instruments offered continuously through agents
• Buyer specifies desired face value & maturity
• Maybe any maturity, not necessarily medium term
• Less liquid than publicly traded bonds from same issuer

Question 24

Macaulay duration

Answer 24

• The time horizon at which reinvestment risk and market price risk offset each other.
• Holding period < Macaulay: Price decrease has more effect
• Holding period > Macaulay: Reinvestment has more effect

Question 25

Quote-Driven Market

Order-Driven Market

Brokered Markets

Answer 25

• Quote-driven markets: Dealers are market makers. Buy & sell from inventory. Post bid & ask prices. Also known as over-the-counter markets. Dealer provide liquidity.
• Order-driven markets: Enchanges, automated trading system. Order matching rules, trade pricing rules. Trader provide liquidity.
• Brokered markets: Broker match buyer & sellers. Trade illiquid asset.