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CFA1 > Equity Investments > Flashcards

Equity Investments Flashcards

1
Q

return on investor’s equity on margin

A

(new stock price-borrowed amount)/initial margin amount-1; ending investment/initial investment-1; (new stock price-borrowed amount paid off-commission to sell+dividend-interest paid)/(initial margin amount+commission to buy)-1

also calc as return without margin loans*leverage ratio

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2
Q

leverage ratio

A

1/initial margin

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3
Q

Financial assets include securities (stocks and bonds), derivative contracts, and currencies. Real assets include real estate, equipment, commodities, and other physical assets.

A
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4
Q

share price for margin call

A

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

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5
Q

primary market is the market for newly issued securities;
secondary market=Subsequent sales of securities

A
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6
Q

Money markets=markets for debt securities with maturities of one year or less

A
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6
Q

Capital markets refer to markets for longer-term debt securities and equity securities that have no specific maturity date.

A
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7
Q

well functioning financial system if

operationally efficient= low trading costs; informationally efficient= security prices reflect all public information;

A

add allocationally efficient=capital is allocated to its most productive uses;

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7
Q

Brokers help their clients buy and sell securities by finding counterparties to trades in a cost efficient manner.

Block brokers help with the placement of large trades.

A

Dealers facilitate trading by buying for or selling from their own inventory.

Dealers that trade with central banks when the banks buy or sell government securities in order to affect the money supply are referred to as primary dealers.

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7
Q

Warrants=give the holder the right to buy a firm’s equity shares at a fixed exercise price prior to the warrant’s expiration.

A

warrants are issued directly by a company seeking capital, while options are derivative contracts traded among investors

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8
Q

call markets=orders are accumulated and securities trade only at specific times; liquid if in sessions;

A

continuous markets=trades occur at any time the market is open with prices set either by the auction process or by dealer bid-ask quotes.

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8
Q

market order=execute the trade immediately at the best available price;

limit order=minimum execution price on sell orders and a maximum execution price on buy orders;

Stop (stop loss) orders=not executed unless the stop price has been reached

A

stop sell order=below the current market price, limit the losses on a long position;

stop buy order=above market price, limit loss on short sell;

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9
Q

day orders, meaning they expire if unfilled by the end of the trading day

A

Good-till-cancelled orders remain open until they are filled;

Good-on-close orders are only filled at the end of the trading day; If they are market orders, they are referred to as market-on-close orders. These are often used by mutual funds because their portfolios are valued using closing prices. There are also good-on-open orders.

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10
Q

quote-driven markets= traders transact with dealers (market makers) who post bid and ask prices. Dealers maintain an inventory of securities (dealer markets, price-driven markets, or over-the-counter markets);

order-driven markets=orders are executed using trading rules first come first serve e.g.Exchanges and automated trading systems; other traders maintain inventory

brokered markets=brokers find the counterparty in order to execute a trade; valuable for illiquid and unique securities; do not carry inventory and too few to trade on order-driven markets

A
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11
Q

price-weighted index

A

arithmetic average of the prices of its constituent securities; denominator adjusted for stock splits and changes in compositions rebalance when stock split;

% price change on high priced stock have greater impact; portfolio with equal numbers of shares of each index stock will match the performance of a price-weighted index

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

end/beg avg sum stock price-1. no div

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11
Q

equal-weighted index

A

arithmetic average of the returns of index stocks matched by the returns on a portfolio that had equal dollar amounts invested in each index stock; when stock price change, port weight change and port must be rebalanced periodically;

place less weight on high-priced stocks but more weight on low-priced; compared to market capitalization-weighted index, place more weight on stocks with small caps;;

calc hpr with div

rebalance quarterly

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12
Q

market capitalization-weighted index (or value-weighted index)

A

current index value

returns are weights based on the market capitalization of each index stock as a proportion of the total market capitalization;does not need to be adjusted when a stock splits or pays a stock dividend;

index security weights represent proportions of total market value.

current total market value of index stocks/
base year total market value of index stocks
×
base year index value

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13
Q

float-adjusted market capitalization-weighted index

A

like market cap-weighted index but adjusts it to only include shares that are publicly traded and available for investors to buy and sell, rather than all outstanding shares. This means that shares held by insiders, government agencies, or other entities that are not freely traded are excluded from the calculation

large percentages of their shares held by controlling stockholders will have less weight than they have in an unadjusted market-capitalization index.

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14
Q

fundamental weighting

A

weights based on firm fundamentals, such as earnings, dividends, or cash flow;

avoids the bias of market capitalization-weighted indexes toward the performance of the shares of overvalued firms and away from the performance of the shares of undervalued firm

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15
Q

Rebalancing

A

periodically adjusting the weights of securities in an index or portfolio to their target weights;

equal-weighted indexes as portfolio weights change as prices change.

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16
Q

reconstitution

A

Securities are deleted if they no longer meet the index criteria and are replaced by securities that do.

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17
Q

Broad market index

A

market’s overall performance and usually contains more than 90% of the market’s total value.

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18
Q

Multi-market index

A

indexes of markets in several countries and is used to measure the equity returns of a geographic region, markets based on their stage of economic development, or the entire world

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19
Q

turnover is high in fixed income indexes cuz maturity shorter

A

trade infrequently, Illiquidity, transactions costs, and high turnover so hard to replicate a fixed income index

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20
Commodity indexes are based on futures contract prices
21
Real estate indexes can be constructed using returns based on appraised values, repeat property sales, or the performance of Real Estate Investment Trusts (REITs).
22
hedge fund indexes equally weight the returns of the hedge funds included
upward bias in index returns, with hedge funds appearing to be better investments than they actually are cuz only report successful ones due to poor ones dont report their performance, less regulated, or didnt survive
23
momentum strategy=stocks that are doing well will continued to do well, vice versa;
value-weighted index=capitalize on stocks that are already doing well. increasing weight on better performaning stocks
24
Efficient Markets Hypothesis (about making abnormal return, not positive return)
weak form (historical)=stock prices fully reflect all market information; if weak form holds, purely TECHNICAL analysis has no value. price and volume information semistrong form (public)=public information cannot be used to beat the market, neither technical nor FUNDAMENTAL analysis has any value in stock selection. Strong-form (private)=stock prices fully reflect all information, both public and private; even private (inside) information would be of no value in selecting securities. developed markets are weak and semi strong
25
Loss aversion = investors to dislike losses more than they like gains of equal amounts.
vs risk aversion
26
Representativeness. Investors assume good companies or good markets are good investments.
27
Mental accounting. Investors classify different investments into separate mental accounts instead of viewing them as a total portfolio.
28
Conservatism. Investors react slowly to changes.
29
Narrow framing. Investors view events in isolation.
30
information cascade occurs when people disregard their private information and imitate others, while herding involves individuals making similar decisions without necessarily ignoring their private information
31
value stock has low price/BV, low PE ratio, high dividend yield cuz D/P where price is low;
32
efficient market hypothesis only look at market not how people act
e.g. informational efficiency
33
participating preference shares=extra dividends if firm profits exceed a predetermined level and recerive greater than par if firm liquidated
Non-participating preference shares have a claim equal to par value in the event of liquidation and do not share in firm profits
34
Private equity
Less liquidity, share price negotiated, less disclosure cuz less regulated, lower reporting cost, potential weaker governance, focus on long term cuz less pressure on short term results, greater return for investors once goes public
35
statutory voting
each share held is assigned one vote in the election of each member
36
cumulative voting
shareholders can allocate their votes to one or more candidates as they choose
37
Direct investing in the securities of foreign
buying a foreign firm's securities in foreign markets
38
Depository receipts (DRs)
domestic bank purchase foreign shares and sell on domestic market; sponsored DRs=foreign firm involved in the issuing of stocks; voting right passed on to investor; SEC registered unsponsored DRs=foreign firm not involved in issuance and the depository bank retains the voting rights on the shares
39
Global depository receipts (GDRs)
trade outside issuers home country and US, denominated in USD, and can be sold to US investors
40
putable shares are less risky and callable shares are more risky compared to shares with neither option
Callable shares are the most risky because if the market price rises, the firm can call the shares, limiting the upside potential of the shares.
40
American depository receipts (ADRs)
denominated and traded in US
41
BV=A-L
market value=total value of outstanding shares based on market prices, reflect investors expectations of firms future performance
42
cost of equity
min required rate of return on equity securities; discount rate; if fail to meet, share price falls; CAPM, WACC, NPV;
42
ROE
E is based on book value; can be increased by increasing debt but also increase risk; increase is not always good;
43
company research report
analyst valuation and investment recommendation; initial report for external distribution is thorough, subsequent report is less thorough includes changes and new information;
44
revenue drivers
bottom-up analysis=revenue broken down by price, volume, segments, geography; top-down=macro, GDP;
45
operating profit = [Q × (P – VC)] – FC
(P – VC) is the contribution margin per unit
46
Economies of scale
increasing output decreases unit costs
46
degree of operating leverage
Operating leverage results from fixed operating costs; percent change in operating profit that results from a given percent change in sales. larger the proportion of fixed operating costs, the more rapidly operating profits will increase or decrease with a given change in quantity sold.
47
Economies of scope
adding divisions or product lines results in decreasing unit costs.
48
degree of financial leverage (DFL)
percent change in net income that results from a given percent change in operating income
49
unlevered return=ROIC
net operating profit less adjusted tax/net operating asset which is invested capital; economic profit=ROIC>WACC
50
levered return=ROE depont
51
defensive company produces goods and services for which demand is relatively stable over the business cycle.
52
cost leadership strategy
lowest costs of production in its industry, offer the lowest prices, and generate enough volume to make a superior return. defensively to protect market share, or offensively to gain market share.
52
Sustaining innovation refers to improvements in a product over time that do not fundamentally change its nature. Disruptive innovation creates a new market or enters an existing market and creates value in a new way.
53
differentiation strategy
products and services should be distinctive in terms of type, quality, or delivery; cost of differentiation must be less than the price premium that buyers are willing to pay and should be sustatinable to remain effective
54
focus strategy
targeting a niche market. can use both cost leadership and differentitation
55
HH=measure of industry concentration, lower means more competitive industry
=sum(market share of each^2); >2500, highly concentrated
56
PESTLE for industry themes; HH for industry concentration; Ports five forces for industry profitability
57
firm with multiple business lines
classified by 1. >60% of revenue, or 2. >50% of revenue, profit, or asset
58
four forecast approahces
use historical results to forecast=assume past trend will continue for noncyclical or mature firms but for cyclical ones, should use multiyear forecast for full business cycle; assume converge to an industry average or median growth rate=should be sufficiently long period and mature industries with few structural change, not for rapid change and new; use mgmt guidance=for proven reasonable estimate managers that give range rather than a point, could give lower growth and higher expense so could exceed expections; discretionary forecasts=survey, model, use when others fall short; dont include nonoccurings; should have multiple assumptions to examine sensitivity of forecasts
59
Forecast COGS = (1 − gross margin) × estimate of future revenue
60
Selling, general, and administrative operating expenses are less sensitive to changes in sales volume
fixed cost component might be modeled using a growth rate that accounts for expected inflation. Selling and distribution costs may be more directly related to sales volume.
61
Historical depreciation is usually the starting point to forecast capital spending for maintenance. account for the expected inflation rate when estimating maintenance expenditures.
62
Forecasting capital expenditures for growth requires an analyst to understand management's future business and revenue growth strategies.
63
Forecasting a firm's capital structure is often based on its leverage ratios.
64
Declaration date= board of directors approves the dividend payment; Ex-dividend date=first day trade withouth div, 1 or 2 days before record day; own the share before ex-div date to get paid Holder-of-record date=people who own shares will receeived div at Payment date=Dividends are paid
65
Taxes aside, neither cash dividends nor share repurchases affect the shareholder's wealth.
66
preferred stock value =D/k
67
constant growth model: P0=D1/(k-g); g = ROE × retention ratio
In practice, however, increasing the dividend will decrease retained earnings and the firm's sustainable growth rate, so we cannot assume that a firm that increases its dividend will increase firm value. when k < g, meaningless
68
Dividend Discount Models (DDM)
P0=D1/(k-g)=>P0/E1=D1/E1/(k-g); g = ROE × retention ratio
69
estimate the growth rate in dividends
1. Use the historical growth in dividends for the firm. 2. Use the median industry dividend growth rate. 3. Estimate the sustainable growth rate. grow indefinitely assuming that ROE is constant, the dividend payout ratio is constant, and no new equity is issued. sustainable growth = (1 − dividend payout ratio) × ROE
70
trailing vs leading PE ratio
market price per share/EPS over last or next 12 months
71
P/B ratio = market value of equity/book value of equity = market price per share/book value per share
tangible book value use book value of equity less intangible assets
72
Enterprise value (EV) =total company value and what it would cost to acquire the firm.
EV = market value of common stock + MV pref+market value of debt long term and short term − cash and short-term investments; Cash and short-term investments are subtracted because an acquirer's cost for a firm would be decreased by the amount of the target's liquid assets.
73
Analysts often consider asset-based model values as floor or minimum values when significant intangibles, such as business reputation are involved cuz intangles are hard to measure
provide floor values.Market values are usually different than book values.
74
style index
size, value vs growth, sector; (no merging markets vs developed markets)
75
cost leadership strategy wants premium-ization among customers; focus trategy risk of large firms outperform on price
76
highly efficient market, intrinsic value (price an investor with full knowledge would pay)=market value (investor expectations of the price,); book value dont typically equal to market value; in asset-based valuation model, due to insuffcient market value, BV is used like FV
77
securities mraket are order-driven; bonds and currencies are quote-driven
OTC is quote driven
78
earn risk adjusted return=means earn abnormal return

CFA1 (11 decks)

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