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CFA level I > Equity investments > Flashcards

Equity investments Flashcards

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1
Q

What are functions of financial system? (3)

A
  1. Allow to save, borrow, raise capital, manage risks and trade assets based on their estimates of value
  2. Determine returns for which savings = total amount of borrowing
  3. Allocate capital in most efficient uses
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2
Q

What are savings?

A

Save for expected return to compensate for risk and use of money

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3
Q

What is borrow?

A

To buy and fund opportunities

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4
Q

What is issued capital?

A

Raised capital with the help of IB

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5
Q

What is risk management?

A

Manage risks with hedging

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6
Q

What is equilibrium interest rate?

A

Borrow = lend

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7
Q

What are examples of financial assets?

A

Securities, derivatives and currencies

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8
Q

What are examples of real assets?

A

Real asset, equipment, commodities and other physical assets

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9
Q

What are public securities?

A

They are traded on the exchange through a dealer and subject to regulation

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10
Q

What are derivative contracts?

A

It is security which value derives from an underlying asset

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11
Q

What are two types of derivatives?

A

Financial and physical

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12
Q

What are spot markets?

A

Markets with immediate delivery

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13
Q

Which assets have future delivery?

A

Forwards, futures and options

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14
Q

What is primary market?

A

Market for newly issued securities

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15
Q

What is secondary market?

A

It is market for subsequent sale of issued securities

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16
Q

What is traded in money market?

A

Debt securities with < 1 year

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17
Q

What is traded in capital market?

A

Securities with longer-term

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18
Q

What are traditional investment markets?

A

Debt and equity

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19
Q

What are fixed income securities?

A

Debt securities that are promised to be repaid

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20
Q

What is commercial paper?

A

Short-term debt issue, similar to bonds

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21
Q

What is repurchase agreement?

A

Borrowers sels high quality asset and has both the right and obligation to repurchase it at the higher price in the future

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22
Q

What is convertible debt?

A

It is debt that investor can exchange for speicified number of equity shares

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23
Q

What is warrants?

A

Option to buy equity at a fixed exercise price prior to expiration

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24
Q

What is mutual fund?

A

It is purchase of shares from a fund itself (open-end) or in secondary market (closed-end)

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25
Q

What are ETF and exchange traded notes (ETN)?

A

They trade like close-end funds but have special provision allowing conversion into individual portfolio securities keeping market price close to the value of proportional interest in overall portfolio

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26
Q

What are asset-backed securities?

A

It is claim to a portion of a pool of financial assets

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27
Q

What are hedge funds?

A

It is fund of wealthy individuals, where investors act as limited partners and fund managers as general partner

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28
Q

What is forward contract?

A

It is agreement to buy or sell an asset in the future at a specified price which is not traded on the exchange

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29
Q

What is futures contract?

A

It is similar to forwards, but is standardized and traded on exchange in the secondary market

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30
Q

What is swap contracts?

A

Two parties make payments that are equivalent to one asset being traded for another

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31
Q

What is interest rate swap?

A

Floating exchange rate is traded for fixed

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32
Q

What is currency swap?

A

Loan in one currency is traded for another

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33
Q

What is equity swap?

A

Equity is swaped with debt

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34
Q

What is an option?

A

It is right to buy or sell an asset at specified price some time in the future and is not traded on the exchange

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35
Q

What is insurance contract?

A

It pays a certain amount of cash if future event occurs and is used as hedging

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36
Q

What is credit default swap?

A

It is payment if an issuer defauls on its bonds

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37
Q

What are real estate investment trust (REIT) or master limited partnership (MLP)?

A

It is when investor owns an interest in these vehicles, which holds assets directly

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38
Q

What are financial intermediaries?

A

They stand between buyer and seller, facilitates exchange of assets, capital and risk

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39
Q

What are brokers?

A

They help client to buy and sell securities by finding counterparties to trade in a cost efficient manner

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40
Q

What are block brokers?

A

They help with placement of large trade and help to conceal client’s intentions so market does not go against them

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41
Q

What are investment banks?

A

They help to sell stock and debt securities to investors

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42
Q

What are exchanges?

A

They are venues where traders can meet and may act as a brokers, can be regualted

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43
Q

What are dark pools?

A

Alternative trading systems that do not reveal current client orders

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44
Q

What are dealers?

A

They facilitates trading by buying and selling from their own investory

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45
Q

What is brokers-dealers conflict?

A

They have conflict as thet want to make profit, but also has to act in the interest of a client

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46
Q

What are primary dealers?

A

They trade with central banks when banks buy or sell government securities

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47
Q

What are securitizers?

A

They pool large amounts of securities and sells interest to other investors

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48
Q

What is primary benefit is securitizers?

A

Decreased funding costs for an asset in a pool

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49
Q

What is special purpose vehicle/equity?

A

It is separate subsidiary to isolate financial risk from investment made by the parent company

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50
Q

What are tranches?

A

They are different risk categories, the more junior, the riskier

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51
Q

What are depository institutions?

A

They pay interest on deposits and provide transaction services while lending to other parties

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52
Q

What is moral hazard?

A

It is taking more risk once you know that you are protected

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53
Q

What is adverse selection?

A

Those most likely to experience losses are the predominant buyers of insurance

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54
Q

What is fraud?

A

It is when insured purposely causes damanges or claims fictious losses so they can collect insurance policy

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55
Q

What is arbitrage?

A

It is buying asset in one market and reselling it in another at a higher price

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56
Q

What are functions of a clearhouses? (4)

A

-Escrow services
-Guarantees contract completion
-Assures that margin traders have adequate capital
-Limits on the aggregate net order quantity of memebers

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57
Q

What are custodians?

A

They provide marekt integrity by holding clients securities and preventing their loss due to fraud

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58
Q

What benefits long position?

A

Increase in the price

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59
Q

What benefits short position?

A

Decrease in price

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60
Q

Which position buyer of an option takes?

A

Long the option

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61
Q

Which position seller of an option takes?

A

Short the option, also says that it writes the option

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62
Q

What are payments-in-lieu?

A

Short sellers must pay all dividends and interest to the lender

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63
Q

What is short rebate rate?

A

It is return of portion of interest gained on deposit of funds that lender pays to borrowers

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64
Q

What is leveraged position?

A

It is purchase of security with borrowed funds

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65
Q

What does it mean to buy on margin?

A

It is borrowing money from broker and buying the security

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66
Q

What is call money rate?

A

It is interest paid to the broker for borrowing the money

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67
Q

What is initial margin requirement?

A

It is minimum equity required during new margin purchase

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68
Q

Formula of leverage ratio of an margin investment

A

value of an asset/value of equity position

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69
Q

How to interpret initial margin requirement of 50% or 2:1 ratio

A

It means that 10% increase in the assets price will requires 20% increase in equity

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70
Q

What is maintenance margin requirement?

A

It is minimum equity requirement, usually 25%, if it falls below, an investor will get a margin call

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71
Q

Formula of margin call price

A

P0*(1- initial margin/1-maintenance margin)

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72
Q

If you buy, what price to propose?

A

Bid price, make the market

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73
Q

If you sell, what price to propose?

A

Ask price, take the market

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74
Q

What is market order?

A

It executes trade immediately at the best possible price

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75
Q

What is limit order?

A

It sets minimum price to sell and maximum price to buy

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76
Q

What is marketable/agrresively priced?

A

It is limit buy order above the best ask and sell order below best bid

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77
Q

What are standing limit orders?

A

It is limit orders waiting to execute

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78
Q

What does it mean to be behind the market?

A

It is buy order with limit price below best bid

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79
Q

What is all or nothing order?

A

It is order to execute only if all order can be fulfilled

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80
Q

What are hidden orders?

A

They are orders of which only brokers or exchanges knows the size of

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81
Q

What is display size?

A

It determines which part of the order size is visible

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82
Q

What are day orders?

A

They expire if unfilled by the end of a trading day

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83
Q

What are good till cancelled orders?

A

Last until they are filled

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84
Q

What are immediate or cancel orders?

A

Cancelled unless filled immediately

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85
Q

What are stop orders?

A

They are orders that are not executed unless stop price has been met

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86
Q

What is indication of interest?

A

It is conducted by the IB to see who would be willing to buy a stock, the process is called book building

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87
Q

What is underwritten offering?

A

It is when IB bank agrees to buy the entire issuance

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88
Q

What is best efforts?

A

It is when bank may but is not obliged to sell the entire issuance

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89
Q

What is private placement?

A

It is when securities are sold directly to qualified investors

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90
Q

What is shelf registration?

A

It is when company makes public disclosures but issues securities over time when it needs capital and when markets are favourable

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91
Q

Wha tis dividend reinvestment plan?

A

It is allowing existing investors to use dividends to buy shares from a firm at a slight discount

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92
Q

What is call market?

A

Securities are traded at a specific time only

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93
Q

What is continous market?

A

Trade occurs any given time the market is open

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94
Q

What is quote-driven market?

A

It is when traders transact with dealers who post bid and ask prices

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95
Q

What is order-driven market?

A

It is when orders are executed using trading rules, as users are anonymous

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96
Q

What are order matching rules?

A

It establishes order precedence hierarchy based on price priority on highest bid and lowest ask

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97
Q

What is secondary precendence rule?

A

It gives priority to non-hidden and earliest arrived orders

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98
Q

What is uniform pricing rule?

A

All trades trade at the same price which results in highest volume of trading

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99
Q

What is discriminatory pricing rule?

A

It is limit price of the order that arrived first as the trade price

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100
Q

What is derivative pricing rule?

A

It is primary exchange bid/ask prices used in third parties platform

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101
Q

What is brokered market?

A

It is when brokers find the counterparty in order to execute the trade

102
Q

What is pre-trade transparent?

A

Investors can obtain pre-trade information regarding quotes and orders

103
Q

What is post-trade transparent?

A

It is when trade information regarding prices and sizes is obtained post trade

104
Q

What are features of a complete market? (4)

A
  1. Investors can save for the future at the rate of return
  2. Creditworthy borrower can obtain funds
  3. Hedges can manage their risks
  4. Traders can obtain the currencies, commodities and other assets they need
105
Q

What is informationally efficient?

A

Securities reflect all the information associated with fundamental value in timely fashion

106
Q

What is operationally efficient?

A

It provides information at a low cost

107
Q

What is allocationally efficient?

A

It is when capital is put to the most productive use

108
Q

What is security market index?

A

It represents performance of an asset class, security market or sequent of a market

109
Q

What are constitunt securities?

A

These are securities in the portfolio

110
Q

What is price index?

A

It is use of constituent securities prices in return calculations

111
Q

What is price return?

A

It is rate of return calculated based on a price index

112
Q

What is return index?

A

It is prices and income from constituent securities

113
Q

What is total return?

A

It is rate of return calculated based on return index

114
Q

What is price-weighted index?

A

It is arithmetic average of the prices of the securities in the index

115
Q

What are disadvantages of price-weighted index?

A

Higher prices stocks have more significances and stock weights changes as prices fluctuates

116
Q

What is equal weighted index?

A

It is arithmetic average return of the index stocks that would be matched by the returns on a portfolio that had equal amounts of euros invested in each stock

117
Q

What is disadvantage of equal weighted index?

A

Portfolio has to be rebalanced each period, larger cap firms have lower weights but their porportion of the overall market is large

118
Q

What is value weighted index?

A

Its when weights are based on the market cap of each index stock as proportion of total market cap of all stocks in the index

119
Q

What is market float?

A

It is total value of shares excluding controlling shareholder

120
Q

What is free float?

A

It is total value of shares excluding controlling shareholder, governments and corporations

121
Q

What is fundamental weighting?

A

Weights are based on firm fundamental

122
Q

What is float-adjusted market capitalization-weighted index?

A

It is like market cap index, but weights are based on proportional value of each firms shares available to the total market value

123
Q

What is formula of price-weighted index?

A

sum of stock market prices/number of stocks in index adjusted for splits

124
Q

What happens to price-weighted index in case of stock splits?

A

We adjust stock’s price and index price has to remain the same

125
Q

What is formula for market cap index?

A

market value of index stocks/base year value of index stocks

126
Q

What is formula of equal weight index?

A

(sum of % changes in prices/number of stocks+1)*initial index value

127
Q

What is rebalancing?

A

It is adjusting weights of securities in a portfolio to their target weights after price changes have affected weights

128
Q

What is reconstitutions?

A

It is adding or deleting securities that make an index

129
Q

What are uses of indexes? (5)

A
  1. Reflection of market sentiment
  2. Benchmark of manager performance
  3. Measure of market return and risk
  4. Measure of beta and adjusted return
  5. Model portfolio for index returns
130
Q

What is broad market index?

A

It measures markets overall performance and contains more than 90% of market’s total value

131
Q

What is multi-market index?

A

It is used to measure equity returns of specific geographical area, economic development stage or entire world

132
Q

What is style index?

A

Represent groups of securities classified according to market capitalization, value, growth, or a combination of these characteristics

133
Q

What are commodities indexes?

A

It is future contracts on commodities

134
Q

What are issues of commodity indexes? (2)

A

Weighting method, futures vs actuals as contracts matures and must be replaced

135
Q

What are real estate indexes?

A

It uses returns based on appraisal of properties, repeat property sale or REITs

136
Q

What strategy should be used in perfectly efficient market?

A

Passive strategy, as active strategy would result in unnecessary costs

137
Q

How efficiency can be determined?

A

It can be determined by the time it takes the activity to reflect new information

138
Q

What is intrinsic or fundamental value?

A

It is value that a rational investor with full knowledge would pay

139
Q

What are factors affecting market efficiency? (4)

A

Number of capital participants, availability of information, impediments to trading, transaction and information costs

140
Q

What is weak form of market efficiency?

A

Current security prices fully reflect all currently available market information, pas information has no power, no risk-adjusted profits can be earned by using technical analysis

141
Q

What is semi strong form of market efficiency?

A

Current security prices reflect all publicly available information (all past information and nonpublic information), positive risk adjusted profits cannot be achieved by fundamental analysis

142
Q

What is strong form of market efficiency?

A

Prices fully reflect all information from public and private sources

143
Q

What is abnormal profit?

A

It is expected return of a trading strategy

144
Q

What is technical analysis?

A

It is gain of risk-adjusted returns by using historical prices and volume data

145
Q

What is fundamental analysis?

A

It is analysis based on the public information

146
Q

What is event study?

A

It is examining of returns before and after release of new information

147
Q

What is market anomaly?

A

It is something that would lead to reject hypothesis of market efficiency

148
Q

What is data snooping/mining?

A

It is investigation of data until statistically significant relation is found

149
Q

What is January/turn-of-the-year effect?

A

During the first five days of January returns are significantly higher

150
Q

What is tax-loss selling?

A

Investors sell long positions in Dec to realize losses for tax purposes and then repurchase stocks in January

151
Q

What is window dressing?

A

It is selling of risky stocks in Dec for reporting purposes and repurchase of stock in January

152
Q

What is overreaction effect?

A

It is firms poor stock return over the last 3-5 years have better subsequent returns

153
Q

What is momentum effects?

A

It is high short-term returns followed by continued high returns

154
Q

What is size effect?

A

Small cap stocks outperform large-cap stocks

155
Q

What is value effect?

A

It is value stocks outperforming growth stocks

156
Q

What characteristics value stocks have?

A

Low P/E and M/B and high div. yield

157
Q

What characteristics growth stocks have?

A

High P/E and M/B and low div. yield

158
Q

What are closed-end investment funds?

A

They trade at price different from NAV, often at large discount

159
Q

What is earnings surprise?

A

It is portion of announced earnings that was not expected

160
Q

What are IPO effect?

A

Usually stocks are underpriced at the IPO day, however long-term performance of IPO shares is below average

161
Q

What is behavioural finance?

A

Actual decision making process of investor

162
Q

What is loss aversion?

A

Investors are more risk averse when faced with potential losses than they are when faced with potential gains

163
Q

What is investor overconfidence?

A

It is overestimation of their abilities to analyze securities info and indentify differences between market intrinsic values

164
Q

What is herding?

A

Mimicking investment actions of other investors

165
Q

What are common shares cahracteristics?

A

Have residual claim on assets, no obligation to pay dividends, determines what dividends will be paid periodically, votes for BoD, mergers and aquisitions and auditor selection, can vote by proxy

166
Q

What are preferrence shares characteristics?

A

Divs are not mandatory, fixed periodic payments, do not have voting rights

167
Q

What is difference between cumulative and non-cumulative shares?

A

Non-cumulative does not have to pay dividends if they miss the payment, whereas it accumulates for cumulative shares

168
Q

What are participating shares?

A

Extra dividends are paid if profits exceeds certain level and may receive value greater than par value when liquidated

169
Q

What are non-participating shares?

A

It is claim equal to par value in the event of liquidation

170
Q

What are convertible preference shares?

A

It can be exchanged for common stock at conversion rate determines when shares are issued

171
Q

What is venture capital?

A

It is venture capital provided to firms early in their life cycle to fund development and growth

172
Q

What is leveraged buyout?

A

Investors buy all firms equity using leverage

173
Q

What is private investments in public equity (PIPE)?

A

It is when public firm that needs capital quickly sells primary equity to investors

174
Q

What is direct investing?

A

Buying securities in foreign markets

175
Q

What is depository receipt (DR)?

A

It is ownership in a foreign firm which are traded in markets of other countries in local currencies

176
Q

What is depository bank?

A

It acts as custodian and manages dividends, stock splits and other events

177
Q

What are sponsored DRs?

A

It is when firm is involved and voting rights are provided

178
Q

What is global depository receipt (GDRs)?

A

They are issued outside US and issuers home country

179
Q

What are global registered shares (GRS)?

A

They are traded in different currencies or exchanges around the world,but are registered in the US

180
Q

What is basket of listed depository receipts (BLDR)?

A

They are exchange traded funds that is collection of DRs

181
Q

What are P/B, M/B ratios?

A

It is market value of equity divided by the book value of equity

182
Q

What is company research report?

A

It is analyst valuation and investment recommendation

183
Q

What is business model?

A

It is key drivers that affect its IS and BS

184
Q

What are analyst sources of information?

A

Info directly from company, publicly available third-party information, proprietary third party information, proprietary primary research performed by the analyst

185
Q

What are bottom up revenue drivers?

A

It is when revenue is broken down into specific drivers (segment, geo, price and volume)

186
Q

What are top down drivers?

A

These are macroeconomic factors such as GDP growth or market share

187
Q

What is pricing power?

A

It is extent to which a company can determine its selling price without hurting sales

188
Q

What are low cost producers?

A

It is company that has significantly lower costs than its competitors and may exceed cost of capital

189
Q

What is commodization?

A

It is moving towards highly competitive market as more participants enter the market

190
Q

What is market size?

A

It is total revenue of all companies in the market

191
Q

What is market share?

A

It is ratio of company’s revenue to the market size

192
Q

What are types of operating costs? (3)

A

by relationship with output, by nature and by function

193
Q

Formula of operating profit

A

Q*[P-VC]-FC

194
Q

Formula of contribution margin

A

P-VC

195
Q

GICS hierarchy structure for classification systems

A

Sector, industry groups, industries, subindustries

196
Q

ICB hierarchy structure for classification systems

A

Industries, supersectors, sectors and subsectors

197
Q

TRBC hierarchy structure for classification systems

A

economic sectors, business sectors, industry groups, industries, activities

198
Q

How to treat a company with multiple business lines?

A

Use one that compromises 60% of total revenue, if none, then 50% of revenue, profits and assets, if non, use judgement

199
Q

What are growth industries?

A

These are markets with growth potential, often new technology

200
Q

What are mature industries?

A

They have little growth potential

201
Q

What is HHI index?

A

Measure of industry concentration

202
Q

How to interpret HHI index scores?

A

Below 1500 is low concentration, 1500-2500 is medium concentration, more than 2500 is high concentration

203
Q

What are PESTEL forces?

A

political, economic, social, technological, legal and environmental factors

204
Q

What is sustaining innovation?

A

It is improvement in product over time that does not change the nature

205
Q

What is disruptive innovation?

A

It creates new market or enters new market and creates value in a new way

206
Q

What are effective competitive strategies?

A

Consistent and positive economic profits over the long run

207
Q

What is cost effective leadership strategy?

A

Lowest costs of production, often lower prices and generate enough volume to make superior return

208
Q

What is differentiation strategy?

A

It is distinctive products in terms of type, quality and delivery

209
Q

What is focus strategy?

A

Targeting a niche market

210
Q

How to forecast lines without clear drivers?

A

Forecast directly or by adjusting historical values

211
Q

What are forecast approcahes? (4)

A

Historical results, historical base rate convergence, management guidance and analyst discretionary forecast

212
Q

How to treat non-recurring items?

A

Not include in the forecast, but might include as a separate line

213
Q

Formula of future COGS

A

(historical COGS/revenue)estimate of future event or (1-gross margin)estimate of future event

214
Q

Formula of inventory forecast

A

Forecast COGS/forecast average inventory or
DOH/(forecast COGS/365)

215
Q

Formula of account payable forecast

A

forecast annual purchases / forecast annual payables or
DPO/(forecast COGS/365)

216
Q

What is maintenance CAPEX?

A

It is expected inflation as replacement costs expected to increase with it

217
Q

What is discounted cash flow models?

A

It is PV of cash distributed to shareholders or PV of cashflows available to shareholders FCFE

218
Q

What are two types of multiple models?

A

Stock price to fundamentals and EV to fundamentals

219
Q

What are asset backed models?

A

It is total value as net book value

220
Q

What are cash dividends?

A

These are payments made to shareholders in cash

221
Q

What is effect of stock dividend?

A

More shares, worth less, total equity remains unchanged

222
Q

What are effects of stock splits?

A

More shares, worth less, no change in owners wealth

223
Q

What shares repurchase signals?

A

That stock is undervalued

224
Q

What is declaration date?

A

It is date boD approves payment of a dividend

225
Q

What is ex-dividend date?

A

It is first day a share repurchase will not receive next dividend

226
Q

What is record date?

A

Date on which all owners of shares become entitled to receive dividend payment on their shares

227
Q

What is DDM model?

A

Intrinsic value of a stock is PV of future dividends

228
Q

Formula of DDM model

A

Sum of discounted dividends

229
Q

Formula of holding period DDM

A

sum of discounted dividends to be received + year-end price/1+ke

230
Q

Formula fo FCFE

A

net income+D&A+ increase in WC-fixed capital investments-debt principle repayments+new debt
or
CFO-fixed capital investment+net borrowing

231
Q

Formula of prefered stock value

A

Dp/kp

232
Q

What is gordon growth model

A

It assumes annual growth rate that is constant

233
Q

What are assumptions of gordon growth model? (3)

A

divs are appropriate measure of shareholders wealth, g and k do not change, ke must be greater than gc

234
Q

How can growth rate estimated? (3)

A

historical, median industry growth, sustainable growth rate

235
Q

What is sustainable growth rate assumptions? (3)

A

ROE is constant, no new equity, dividend payout is constant

236
Q

Formula of sustainable growth rate

A

(1-dividend payout ratio)*ROE

237
Q

Formula of multistage dividend discount model

A

sum of D/(1+k)^n+Pn(1+ke)^n
where
Pn=(Dn+1)/k-g

238
Q

What is price multiple approach?

A

Compare stock’s price multiple to a benchmark value based on an index, group of firms or peer group within industry

239
Q

What is price multiple based on fundamentals?

A

It is absolute value, given on some inputs and valuation

240
Q

Formula of P/E ratio

A

stock price/EPS

241
Q

Formula of price-sales ratio

A

stock price/sales per share

242
Q

Formula of price-book ratio

A

stock price/book value of equity per share

243
Q

Formula of price-cash flow ratio

A

stock price/cash flow per share

244
Q

What is justified P/E?

A

Assuming that we have correct inputs, P/E ratio will relfect PV of future cash flows

245
Q

What is purpose of valuation on multiple comparables?

A

It helps to evaluate whether an asset is valued properly relative to a benchmark

246
Q

What is law of one price?

A

Two identical assets should sell at the same price

247
Q

Formula of EV

A

market value of stock+market value of debt-cash and short term investment

248
Q

Why cash and short term investment is deducted from EV?

A

Because aquirer’s cost of capital would be decreased by this amount

249
Q

Why analyst uses asset based model?

A

It is used for private firms as well as floor value for firms with significant intangibles

250
Q
A

CFA level I (12 decks)

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