Equity Investments Flashcards
Capital Appreciation
Capital appreciation is the increase in the market value of an investment or asset over time. It’s calculated by subtracting the purchase price from the selling price of an investment. For example, if an investor buys a stock for $10 per share and the price rises to $12, the investor has $2 in capital appreciation
Dividend Income
Dividends are the percentage of a company’s earning that is paid to its shareholders as their share of the profits. Dividend income is defined by the IRS as any distribution of an entity’s property to its shareholders. An important component of equity returns; As dividends are considered income they are subject to taxes; depending on the dividend they are taxed as ordinary income or capital gains
Diversification
Equity securities offer diversification benefits due to less-than-perfect correlation with other asset classes. When assets are less than
perfectly correlated, portfolio standard deviation will be lower than the weighted sum of the individual asset standard deviations
Inflation Hedge
an investment that is made for the purpose of protecting the investor against decreased purchasing power of money due to rising prices of goods and services. The ideal investments for hedging against inflation include those that maintain their value during inflation or that increase in value over a specified period of time
Client Constraints
may include environmental, social, and governance (ESG) considerations and religious beliefs. Portfolio managers can address these constraints using the following:
- Negative screening (i.e., exclusionary screening), which excludes companies or sectors that do not meet client standards.
- Positive screening (i.e., best-in-class screening), which seeks to uncover companies or sectors that rank most favorably with clients.
- Thematic investing screens equities based on a specific theme, such as climate change. A related approach is impact investing, which aims to meet investor objectives by becoming more actively engaged with company matters and/or directly investing in company projects
Equity Investment Segmentation
There are three main segmentation approaches: size and style, geography, and economics activity (see next three definitions)
Segmentation
Size and Style
Size and Style
Size, typically measured by market capitalization, can be categorized by largecap, mid-cap, or small-cap companies. Style can be categorized by growth or value companies, or a mix of these two
styles (sometimes referred to as blend or core). Investment style can be determined by analyzing company metrics, such as price-to-earnings ratios, priceto-book ratios, dividend yield, and earnings and/or book value growth. A style box can be used to rank (or score) companies or portfolios among to these metrics
Segmentation
Geography
This approach categorizes international markets by stage of economic development, such as developed markets, emerging markets, and frontier markets. Examples for each economic development stage include the following:
- Developed markets: United States, United Kingdom, Germany, Australia, and Japan.
- Emerging markets: Brazil, Russia, India, China, and South Africa.
- Frontier markets: Argentina, Estonia, Nigeria, Jordan, and Vietnam
Segmentation
Economic
This approach groups companies into sectors or industries by applying either a market-oriented or a production-oriented approach.
A market-oriented approach segments companies by markets served, how products are used by consumers, and how cash flows are generated. A production-oriented approach segments companies by products manufactured and inputs required during the production process. Note that applying either approach may lead to slightly different classifications. For example, a market-oriented approach may classify a coal company in the energy sector, while a production oriented approach may classify that same company in the basic materials sector.
The four primary classification structures for segmenting companies by economic activity are:
* Global Industry Classification Standard (GICS).
* Industrial Classification Benchmark (ICB).
* Thomson Reuters Business Classification (TRBC).
* Russell Global Sectors Classification (RGS)
Equity Indices and Benchmarks
Equity market indices and equity portfolio benchmarks can be constructed based on a combination of size/style and geographic segmentation. For example, the MSCI Europe Large Cap Value Index and the MSCI China Small Cap Index combine elements from both size/style and geographic classifications. . Economic activity can also be used to subdivide equity indices by sector or industry. For example, the MSCI World Energy Index and the S&P Global Natural Resources Index track global companies categorized by sector/industry. Equity indices can also track unique client considerations, such as ESG practices.
- Equities typically offer diversification benefits when combined with other major asset classes in a portfolio. Discuss two reasons an economic crisis may affect the risk reduction archived through diversification?
Risk reduction is likely to be less than expected.
* The correlations are likely to move upward towards 1.0.
* The volatility of the assets is likely to increase
- Assume an investor is segmenting the equity investment universe by economic activity. Describe two advantages for applying this segmentation approach
- It allows portfolio managers to analyze, compare, and construct
performance benchmarks based on specific sectors or industries. - Diversification benefits are enhanced when investing across
sectors or industries
Optional Stock Dividend
Allows investors to choose between cash payment or stock dividends (i.e new shares). This “option” between cash and stock has value for the investor and can even be sold to another investor to immediately monetize the “option”
Special Dividend
a one-time cash payment to investors (as opposed to the more typical periodic regular dividend)
Securities Lending
Another way to generate current income. Securities lending is
often part of short selling. A short sale is the sale of a security that is not owned. To make the short sale, the seller must typically borrow the security in order to deliver it to the buyer when the short sale is made. The lender of the security is typically paid a fee and may also receive collateral or cash on which they can also earn a return. The lender also receives back the security lent at a future date. Securities lending is not unusual in index funds large institutional portfolios such as pension funds and endowments
Stock Lending
Stock lending, also known as securities lending, is when you loan shares of stock that you own to another party, usually a financial institution, for a fee and interest charges. The borrower can use the stock for trading activities, such as short-sell trades, hedging, and arbitrage. You can earn money from stock lending by collecting a monthly fee from the borrower
Covered Call
strategy involves writing a call option on a stock owned. The writer then loses the upside of the security if the price increases above the strike price
cash-covered put
This involves selling a put option on stock and setting aside sufficient cash equivalents to pay for stock if the put buyer exercises their right
