Exam 2 Flashcards
The graphic relation between YTM and term to maturity
The yield curve
Structure of interest rates
A downward sloping yield curve
Inverted curve
A blend of returns from the multiple coupons and principal received at various times
YTM on a coupon bond
A “pure” annualized return through the maturity date
YTM on a zero-coupon bond
The implied future one-year interest rate that makes the cumulative return from investing in a pair of Strips, the first bought now and maturing at T-1, and the second bought at T-1 and maturing at T, equal the cumulative return on a strip bought now and maturing at T
One-year forward rate
States that yields to maturity on long-term bonds are determined solely by market expectations of future short-term interest rates
Expectations Hypothesis
If investors expect economic growth to accelerate, then they will generally expect short-term rates to rise in the future
Expectations of economic growth
If investors expect inflation to rise in the future, then they will generally expect short-term rates to rise. To preserve the same pre-tax real interest rate, short-term rates must increase one-for-one inflation
Expectation of inflation
Postulates that investors demand a yield spread or premium for purchasing long-term bonds rather than short-term bonds, because short-term bonds are inherently more liquid
The liquidity preference theory
Three risks to think about when investing in Treasury securities:
Price risk, reinvestment risk, and inflation risk
The risk that the price of a bond will be low at a time you might want to sell it. There is none if you hold until maturity
Price Risk
The risk that market interest rates will be low when you want to reinvest the principal from a maturing bond, or reinvest bond coupons
Reinvestment risk
The risk that consumer prices will rise, reducing the purchasing power of the principal and coupons on your bond
Inflation risk
Stock represents ownership shares in a corporation, shareholders own a part of the company in which they have invested
Common stock
Oversees all operations of the company
Board of directors
Staggered election
Classified board
When a board member is a current or former company executive
Inside director
Sets the compensation of top executives
Outside directors
When there are two competing slates of candidates for the board of directors
Proxy fight
Payments of cash from the company to its shareholders
Cash dividends
Usually one business day before the record date
Ex-dividend date
As the ratio of dividends per share to earnings per share over the past 12 months
Payout ratio
Equal to the current annualized dividend as a percentage of the current stock price
Dividend yield
When a corporation buys its own stock
Share repurchase or buyback
Specifying a single price or range of prices they will pay for each share tendered
Tender off
the company is like any other buyer of stock in the market, so individual shareholders get cash only if they sell their shares in the market
Open market repurchases
Each share of stock will be split into more than one share
Stock split
When companies go public, they usually sell stock, and the stock sale is the ___
Initial Public Offering (IPO)
The price that is paid by public investors to the company for the new shares
Offering price
The SEC registration of securities (stocks and/or bonds) for an offering to be made on a continuous or delayed basis in the future
Shelf registration
The latest trade price for the stock
Last Trade
Highest price anyone is bidding to buy the stock from you
Bid Price
The lowest price anyone is asking to sell the stock to you
Ask Price
These figures indicate the range of the stock price over the past year, adjusted for stock splits if any
52-week high and low
The most recent cash dividend paid, usually expressed on an annualized basis
Dividend
The dividend yield, equal to the annual dividend as a percentage of the current stock price
Yield Percentage
Equal to the current stock price dividend by latest 12-month reported EPS
Price-to-earnings ratio
Current price divided by the consensus forecast of next year’s earnings per share
Forward P/E
Measures the total market value of all the stock outstanding, equal to share price times the number of shares outstanding
Market capitalization
The number of shares traded
Volume
Change in price from the previous day
Net change
Indexes measure how prices for stocks as a group (or on average) are behaving
Stock market indexes
Investors can earn from investing in stocks rather than investing in (safer) bonds
Risk Premium
The component of a stock’s risk that is related to the stock market as a whole
Market risk or systematic risk
Measures the general sensitivity of the return on a stock to the return on the overall stock market
Beta
A beta above 1
Cyclical stock
A beta below 1
Defensive stock
Dividing of investment funds among different securities
Diversification
Publicly traded companies that purchase and typically manage commercial real estate
Real Estate Investment Trusts (REITs)
Difference between bid and ask prices
Bid-ask spread
Number of shares available to buy or sell at that ask or bid price
Depth
Market orders are executed at a price better than the current quote
Price improvement
An order to buy or sell a particular number of shares at a certain price or better
Limit order
An order to sell at the market if the bid price reaches or falls below a particular price
Stop-loss order
Regular brokerage accounts
Cash accounts
You are allowed to borrow a part of your investment from your broker
Margin account
published daily in the Wall Street Journal, is the rate banks charge to brokers to borrow money, and is usually a couple percentage points above the interest rate on Treasury Bills
Call money rate
you first borrow shares from your broker, immediately sell them in the market, and then buy them back at a later date to return to your broker
Short selling
The number of a company’s shares that have been sold short
Short interest
Total shares outstanding minus shares held by corporate insiders
Float
Insider trading (legal and illegal)
The legal version is when corporate insiders—officers, directors, and employees—buy and sell stock in their own companies.
Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security.
Realized when you sell a stock for more (or less) than you originally paid for it
Capital gain (or loss)
The amount you originally pay for a stock
Cost basis
The higher the expectations for future economic growth and inflation, the more ____ will be the yield curve
Steeply sloped
Long-term bonds are inherently ____ than short-term bonds, and hence longer bonds have a positive liquidity ____ in their yields
Less liquid
Premium
Long-term bonds are more subject to the risk of higher ____ than short-term bonds, so long-term bonds have an inflation risk ____ in their yields
Inflation
Premium
Since most investors have relatively short time horizons, ___ risk is more important than ___ risk, so long-term bonds have a ___ risk premium in their yields
Price risk
Reinvestment risk
Price risk premium
Can be redeemed by the issuer prior to the bonds’ maturity date, in exchange for the call price
Callable bonds
The call price is ____ than or equal to the __ value, often starting at a ____% premium to par and then declining to par as maturity approaches
Greater than or equal to the par value
3-5% premium
Motivations for calling a bond (3):
- Reducing interest expenses going forward by refinancing
- Deploying excess cash
- Fear of higher market rates, extend maturity now!
Alternative to calling a bond:
Buy back your company’s bonds on the open market
Allows the issuer, at its option, to redeem the bonds. Issuers may exercise after a certain number of years, often ten years
Optional Redemption
Requires the issuer to regularly redeem a fixed portion or all of the bonds in accordance with a fixed schedule
Sinking Fund Redemption
These days, most callable bonds have ___ redemption, and do not have ___ redemption
Optional
Sinking fund
Period during the first few years of the bond’s life, where calls are prohibited
‘Lockout’ period
When a callable bond is trading at a premium to the call price, and is thus likely to be called, ____ may be misleading
YTM
Annualized rate of return from purchasing the bond and then holding it until the next likely call date, assuming no default and that the bond will actually be called
Yield to call
Yield to call calculation is the same as the YTM calculation, with the ____ date substituted for the ___ date, and the ____ substituted for the par value
call date substituted for the maturity date
Call price
At a specified date, the holder can choose to redeem the bond for par value, or alternatively choose to keep it, effectively extend the life of the bond for a given number of years
Puttable bonds
Allow the holder to convert their bond to common stock in a predetermined ratio
Convertible bonds
Predetermined ratio for convertible bonds is called the
Conversion ratio
Par value of the bond divided by the conversion ratio
Conversion Price
Conversion ratio times the market price per share of the common stock
Conversion Value
Difference between the market price of the convertible bond and the conversion value
Conversion Premium
When issued, the coupon rate on convertibles is set ______ for ‘straight’ bonds of the same credit rating
Below the market rate
When issued, the convertibility option is “_______” (the conversion value is less than par), so that immediate conversion would not make sense
“Out-of-the-money”
Many convertible bonds are ____
Callable
When a convertible is called at a time when the conversion value exceeds the call price, such a call is said to ____ conversion into stock
“Force”
In general, it is not logical to convert unless the ____ price in the market exceeds the ____ price, and even then, it usually makes sense to defer conversion for as long as possible
Stock price
Conversion price
If yields on long-term bonds ___ yields on short-term bonds, the yield curve is said to be upward sloping
Exceeds
If yields on long-term bonds are less than yields on short-term bonds, the yield curve is said to be ____ sloping
Downward
Expectations hypothesis states that yields to maturity on long-term bonds are determined solely by market expectations of …
Future short-term interest rates
Under the expectations hypothesis theory, if the yield curve slopes upward (downward), that means investors believe future short-term rates will be ____ than current short-term rates
Higher (lower)
In terms of forward rates, the expectations hypothesis states that the one year forward rate is always equal to ____ expected one year actual or ‘spot’ rate between T-1 and T.
The market’s
The slope of the yield curve is a _____ indicator
Leading economic
If investors expect inflation to rise in the future, then they will generally expect short-term rates to…
Rise along with it
Inflation:
To preserve the same pre-tax ___ interest rate, short-term ___ rates must increase one-for-one with inflation
Real
Nominal
The yield curve will have a ____ slope when investors believe the economy will improve and/or inflation will increase in the future
Steep upward
The yield curve will ___ when a recession, possibly combine with lower inflation, is predicted
Invert
If future economic growth and inflation are expected to be about the same as they are now, the yield curve will be ___
Flat
The liquidity preference theory postulates that investors demand a yield spread or premium for purchasing ____ bonds rather than ____ bonds, because ___ bonds are inherently less liquid
Long-term
Short-term
Long-term
In practice, long-term treasury bonds are _____ liquid, so it is not clear that any sizable “term” spread can be explained by liquidity differences alone
Highly
Relative risks of investing in short-term versus long-term bonds
- Price risk
- Reinvestment risk
- Inflation risk
Difference between investing in bonds versus bond mutual funds:
Bond mutual funds never mature!
Treasury bonds and notes have no _____
Risk of default
The dividends paid by treasury bonds and notes are taxable by the _____, but you get a break on your _____
Federal government
State income taxes
U.S. government agency funds like GNMA (Government National Mortgage Association) are _____
Mortgage-backed securities (MBS)
MBS bonds are very low ____ and are highly ___, though only GNMA securities are considered perfectly default-free like treasury bonds
Default-risk
Rated
MBS funds have ____ risk, because homeowners have the option to ___ their mortgage loans
Prepayment
Prepay
Junk bonds promise a ____ than government or corporate investment-grade bond, but with ____ risk
Higher return
Higher
If the country were to ever go into a deep recession or depression, ___ bonds could be expected to perform very poorly, right at the same time that stocks would be doing ___
Junk bonds
Poorly
Defaults have ____ significantly in past recessions
Risen
One indicator of the potential future return on bond fund investments is the _______ of the fund
Weighted-average yield to maturity
The yield to maturity on a bond is the _____ from holding a bond to maturity if the bond does not ____
Average annual return
Default
Do not invest in junk bond funds unless the YTM is ______ the yield on investment-grade corporate or treasury bond funds
Well above
Dividends paid by municipal bond funds are _____ by the federal government
Not taxable
What is the difference between national and single-state municipal bonds?
National municipal funds buy municipal bonds from all around the country while single state municipal funds invest in the municipal bonds of a specific state
For wealthy individuals living in a state with a high income tax rate, like New York or California, single state funds can be ___, because their dividends are exempt from ___ income tax and ___ income tax for ____
Attractive
Federal
State
Residents of that state
Invest in bonds issued by foreign companies and governments as well as domestic bonds
International bond funds
International bonds:
Expense ratios are often ___, and your investment is subject to ____
High
Currency risk
International bonds:
Purchasing these funds often amounts to a bet that the U.S. dollar will ____ against other currencies
Depreciate
Within many of these general fund categories, you can find funds that specialize by their maturity. For example, your can buy ___, ___, or ___, maturity U.S. Treasury Bond funds
Short, intermediate, or long maturity
Historical returns:
Look for a fund that earns returns above the average for its fund type over the past ____ years
5-10
Historical returns:
Compare returns on a short-term Treasury fund to ______, not to ______
Other short-term Treasury funds, not to corporate or municipal funds
Manager Tenure:
If a fund has a good long-term record from active bond investing, check to see if the _____ has changed. If the _____ is gone, past performance has no predictive value
Management team
“Star” manager
Default Risk:
U.S. Treasury funds are _____. Corporate and municipal bond funds have ____ default risks depending on their ____
Default-free
Varying
Credit quality
Investors that are very risk averse should generally avoid ___ bond funds
Junk
Interest Rate Risk:
Interest rate risk is higher for ____ bond funds than for ____ funds
Long-maturity
Short-maturity
If you have a short investment time horizon of only 2-3 years, you probably should avoid ____ funds
Long-maturity
The interest rate risk of bonds and bond funds is measured by ____
(Modified) Duration
The ____ the duration of the bond fun, the ____ the interest rate risk
Longer
Higher
Interest Rate Risk:
As an approximation, if the fund has an average modified duration of 7 years and interest rates in the market rise by 1%, say from 5% to 6%, the NAV of the fund will fall by about __%. If interest rates fall by __%, the NAV will rise by about 7%
7%
1%
Expense Ratio:
Look for a fund that has expenses below ___ of assets per year. The larger, more efficient funds are able to keep their expense that low
0.4%
Turnover:
Turnover refers to the fund’s _____
Trading frequency
Turnover:
A turnover rate of 20% indicates that ____ of the securities held at the beginning of the year are sold and traded for other securities during the year
one-fifth
A turnover of ___ indicates that the average security in the portfolio is held for one year
100%
All else equal, ___ turnover is undesirable, because it indicates that fund incurs high transaction costs and may frequently realize taxable short-term capital gains
High
_____ bonds funds will naturally have higher turnover than ____ funds, because their bonds mature _____
Short-term
Long-term
Much more frequently
High turnover (more than 100% per year) in a long-term bond fund is a sign that the manager is trying to ___ interest rate movements by ___ bonds
Time
Trading
A manager trying to time the market buys longer maturity bonds when they expected interest rates to __, and buyers shorter maturity binds when they expect rates to __
Fall
Rise
Dividends from corporate bond funds are subject to ______ income taxes
Federal, state, and local
U.S. Treasury Bond fund dividends are exempt from __ and __ income taxes for the portion of their earnings (usually well over 90%) that comes from Treasury Bonds
State and local
Federal municipal fund dividends are exempt from ____ income taxes, while individual state municipal fund dividends are exempt from __ and __ taxes
Federal
Federal and state (if you live in that state)
Historically, most bond mutual funds slightly ___ the overall bond market
Underperform
Choose a bond with no ____, low ____, and low ____. These funds usually generate the best ____
No sales loads
Low expenses
Low turnover
Long-term returns
Net cash flows into bond funds are ___ correlated with the change in bond yields over the past 12 months
Negatively
Low market interest rates imply ____ returns from bond fund investing!
Low FUTURE returns
Represents ownership shares in a corporation
Common stock
A few corporations sell shares directly to the public using _____
Direct stock purchase plans
Public corporations hold annual meetings, and prior to each annual meeting, common stockholders receive a ballot to vote on candidates for the corporate ____
Board of directors
Board with a staggered election, so that (for example) each director has a three-year term and 1/3 of directors come up for election each year
Classified board
When a board member is a current or former company executive, they are called ___
Inside director
The compensation committee, a committee of the board including only ___ directors, sets the compensation of top executives
Outside
Who decides on if a company will pay a dividend and what amount it would be?
The board
Except in unusual circumstances, directors run ___
Unopposed
If a company has _____, election requires a “for” vote majority, versus ____ or ____ votes
Majority
“Against” or “withheld”
With majority voting, a director must be replaced if ____ votes exceed ____ votes, with the new director selected by the nominating committee of existing directors
“Against” or “withheld” votes exceed “for”
With ____ voting, if a director runs unopposed, the director is elected with only a single __ vote, so the individual stockholder’s vote is basically meaningless
Plurality
“For” vote
When there are two competing slates of candidates for the board of directors, this is referred to as a ____
Proxy fight
The annual ballot sent to shareholders also contains various proposals made by ___ and/or ___
Managers and/or outside stockholders
Proposals by management include (3):
- Whether or not to accept a merger with another company (though this usually has a separate special vote)
- The adoption of stock option incentive plans for top managers
- Hiring a particular account firm to audit the company’s financial statements
Proposals by outside stockholders include (3):
- Limits on the pay or bonuses of executives
- Disclosure of political contributions
- Restrictions on doing business in countries that allegedly violate human rights
The proposals by outside shareholders are just ___ in most cases, not ____, but most CEOs do not want to be seen as totally disregarding the will of the shareholders
Advisory
Legally binding
Normally, each share of common stock carries ___ vote, but sometimes there are different ___ of common stock with different privileges or voting rights
One vote
Classes
Unlike the holder of a corporate bond, common stockholders are not entitled to _____
Receive any particular income payment from the company
If a company gets into financial difficulties and must liquidate (sell) their assets in a bankruptcy proceeding, ____, other _____, ____, and ____ have first claims on the money
Bondholders, other lenders and creditors, lawyers, and the IRS
Common stockholders have a __ or __ claim in bankruptcy which means common stockholders will be the _____ if the company must liquidate
Junior or residual
Last to be paid
On the plus side, common stockholders in a corporation have _____, they are not personally liable for the corporation’s debts, so can never lose more than their ___ in the stock
Limited liability
Original investment
Hybrid of common stock and a corporate bond
Preferred stock
Preferred stock normally pays ___ dividends, as a fixed percentage of the ____
In this sense, preferred stock is more like a ___ than a ____
Quarterly
Par value
Bond than a common stock
Failure to pay a scheduled dividend does not trigger _____, like would a failure to pay ___ or ___ on a bond
However, missed dividends often provide preferred stockholders collectively with a ______
Bankruptcy
Interest or principal
Certain number of seats on the board of directors
The dividend on preferred stock can be either ___ or ___
If the former, then all dividends payments that were missed must be made up before…
Cumulative or non-cumulative
Any dividends can be paid to common stockholders
Most preferred stock issued by banks is _____, which helps satisfy capital requirements with bank regulators
Non-cumulative
Most preferred stock is ____, like common stock. Many preferred stocks have a maturity or mandatory redemption date, like a bond. Many preferred stocks are ____ at their ___ value after a certain number of years
Perpetual
Callable at their par value
In the case of bankruptcy, preferred stock is ___ to common stock, but ___ to all liabilities
Senior to common stock but junior to all liabilities
Sometimes preferred stock is ____ into common shares
Convertible
Convertible preferred is often used in _____, where the company is not yet profitable and hence cannot take advantage of the tax-deductibility of convertible bond interest payments
Venture capital situations
A stock has real value only to the extent that the company can…
Distribute cash to stockholders at some point in the future
The ___ the present value of the expected cash flows paid from the company to stockholders, the ____ is the stock
Higher
More valuable is the stock
Cash distributions primarily take the form of ____, but can also come through ____. You can also receive cash if another company buys your stock for cash in a _____
Cash dividends
Share repurchases
Corporate takeover
Earnings can be… (4):
- Paid out to stockholders as dividends
- Used to pay off debt or repurchase stock
- Used to buy another company
- Reinvested into the business
Most dividends are so-called ____ dividends, paid on a regular basis, typically _____. Companies can also pay special ____ extra dividends if they choose
Regular
Quarterly
“One-time”
Dividends are always announced in the _____ prior to their ____
Financial press prior to their actual payment
Date that is usually one business day before the record date
Ex-dividend
Example:
A company announces on March 15th that it will pay a $0.30 dividend on April 20th, to shareholders of record at the close of business on Friday, April 1st, with an ex-dividend date of March 31st. What date is the deadline of owning a stock to get the dividend?
March 30th, the day before the ex-dividend date
If you buy a stock on the ex-dividend date of March 31st or later, you do not receive the dividend
Stock prices usually fall by approximately the ______ at the open of trading on the ex-dividend date, so there are no easy profits to be made by buying the stock the day before the ex-dividend date and selling it on the ex-dividend date
Amount of the dividend (or a little less)
By paying a dividend, the company is basically saying that stockholders should be able to invest ____ other than have the ____
Extra cash themselves rather than have the company do it for them
The payout ratio is defined as the ratio of ____ per share to ____ per share over the past 12 months
Dividends per share to earnings per share
Payout ratio example:
If the company earned $2.00 per share and paid $0.60 in dividends over the past year, the payout ratio is ___
30%
The higher the payout ratio, the larger is the percentage of ___ that are ____
Earnings that are paid out as dividends
Dividend yield is equal to the current _____ / current ____
Current annualized dividend/Current stock price
Dividend yield example:
If the company last paid a regular quarterly dividend of $0.22/share, and paid no extra dividends in the past year, then the annualized dividend is ___. If the current stock price is $31, the dividend yield is __/__ = __
$0.88
$0.88/$31 = .0284 or 2.84%
The dividend yield measures the ____ produced by the stock per dollar of investment, and is somewhat analogous to the yield on the bond
Current income
All else equal, a stock with a ____ ratio and a ___ dividend yield is more attractive to buy than a stock with a ____ ratio and a ___ dividend yield
Low payout ratio and a high dividend yield is more attractive to buy than a stock with a high payout ratio and a low dividend yield
The former stock pays ____ as a percentage of the stock price, and reinvests a _____ of it profits back into its business for the future
The latter stock pays _____ as a percentage of the stock price, and ____ of its profits for the future
Current income
High percentage
Little current income
Does not invest much of its profits for the future
“All else” may or may not be equal, but be wary of stocks with high ____ and low ____
High payout ratios and low dividend yields
There is no iron-clad rule on whether paying dividends is “good” or “bad” for the investor. Dividend payments are good if the company does not have _____ available
Profitable investment opportunities
Stocks in industries like ____ tend to pay high dividends, while ______ companies often do not pay a dividend, reinvesting all of their profits
Utilities, banks, real estate, and insurance
Technology and smaller, startups
Some companies prefer to distribute cash through ___ rather than ____
Share repurchases rather than dividends
When dividends are cut, that is a sign that the company might be ____, so the stock price usually ___
Short of cash
Falls
A dividend serves as a signal that ____ are likely to be relatively stable
Future cash flows
Higher pay (and prestige) for bigger size companies can lead some CEOs to reinvest _____, or buy other companies, just to ____
Too much back into the business
Make the company larger
A policy of paying regular dividends provides some useful restraint on the ____ of the company. The company may ave to choose between maintaining ___ and ____
Capital expenditure plans
Maintaining dividends and higher capital expenditures
To maintain the dividend, the company may have to limit itself to only the ____ and forego more ____ plans
Best opportunities
Questionable or risky expansion plans
When a corporation buys its own stock, it is called a ___ or ___
Share repurchases or buyback
On some occasions, companies will make a formal _____ to shareholders specifying a single price of range of prices they will pay for ____
Tender offer
Each share tendered
Tender offers are relatively ___. Companies, will announce that they will be buying their own stock in the ____ using a stockbroker
Rare
Open market
With ______, the company is like any other buyer of stock in the market, so individual shareholders get cash only if they sell their shares in ____. Those shareholders that do not sell end up with a ______, because the repurchase shares are _____.
Open market repurchases
The market
Larger ownership share of the company because the repurchase shares are no longer outstanding
Companies are not required to buy all or even any of the authorized number of shares in open market repurchase program as long as they have a ______
Reasonable justification for their behavior
Any company that ____, ____, and ____ will lose credibility with the market
Announces a repurchase, sees their stock price languish or fall, and does not actually buy many shares
Each quarterly balance sheet reports ____, so investors can keep track of whether management is ____
Shares outstanding
Actually following through
Often shares are repurchased simply to ____ issued to employees through ___ and ___
Offset shares
Stock options and stock grants
Announcements of share repurchases are usually _____ for stockholders because it may indicate or signal that management feels that their own stock is ___ in the market
Good news
Undervalued
After shares are repurchased, there is less ___ on the company’s books and fewer ______. Each remaining share represents a ____ fraction of the company’s underlying business operations than before. If the company has debt on its balance sheet, the company is now more _____. If the company’s business performs well in the future, remaining shareholders will ____ from owning a larger piece of the pie
Cash
Shares outstanding
Larger
Highly leveraged
Profit
When the board of directors announces a ____, each share of stock will be split into ____ share
Stock split
More than one
When a stock split takes effect, the price of each share ___ roughly in proportion to the ___
Falls
Split
A 2-for-1 split will cause the price of each share to fall approximately..
In half
At the time of a stock split announcement, the stock price usually ____
Goes up a bit
Few investors would really be prevented from buying as long as the stock price did not exceed ____, but many companies split before the stock exceeds ____
$500-$1000
$100 or $150
A tiny stock split
Stock dividend
Stock dividend example:
A 10% stock dividend means that for every 100 shares you now own, you end up with ___
110 shares
Do not confuse a stock dividend with a cash dividend paid on your stock, a stock dividend gives you ___
No cash
The stock of a privately owned company does not ____
Trade on a stock exchange
Why do companies ‘go public’?
It allows the firm’s stock to trade on an exchange and be bought and sold by anyone
When companies go public, they usually sell stock, and the stock sale is called an _____. Some of the stock offered is brand new stock that goes ____, and some of the stock is existing stock held by ____
Initial public offering (IPO)
Into the business for future expansion
Private shareholders
The price that is paid by public investors to the company for the new shares
Offering price
Frequently, the demand for initial public offering ___ supply, and the shares must be rationed among the _____
Exceeds
Different brokerage firms underwriting the offering
Customers that trade frequently with the broker, and thus generate considerable commission revenue, are most likely to ____ in an IPO
Receive an allocation
Who is a broker’s best customer?
Institutional investors, such as mutual funs, pension funds, and hedge funds
Underwriting brokerages earn a spread between the ___ and the ___ to the company for their efforts, and the (small) risk that the _________
Offering price and the proceeds
Market will collapse overnight and they will not be able to sell all of the shares to the public
Those investors fortunate enough to be allocated shares in a “hot” IPO often ___ their shares. Underwriters do not always appreciate this as it places ____ on the price of the stock
Flip
Downward pressure
Investors that are able to buy an IPO at the offering price usually do ___ in the short run, but purchasing IPOs in the secondary market on or soon after the offering date has _____
Pretty well
Not proven to be a profitable strategy
Most IPOs perform relatively poorly over the __ years subsequent to the ____
3-5 years subsequent to the offering day
A potential investor should be particularly careful when the original private shareholders sell a large percentage of their own shares in the IPO. This is a clear case of (legal) _____.
Insider trading
Often, ____ is cited as a reason for selling stock, but remember that the original shareholders are _____ than the general public about the _____.
Diversification
Far better informed about the true health of the company
Companies that already trade on a stock exchange can issue more stock to the public through a ____. Most of these are sold through an ___ just like the typical IPO. The offering price usually _____ the stock price at the close of trade on the previous day
Seasoned issue
Underwriting syndicate
Close to but a little below
Sometimes new stock is sold through a ___ rather than through an underwriter. This means the company simply grants rights to buy new shares, at a ____, to _____ in proportion to their ____
Rights offering
Significant discount to existing stockholders in proportion to their ownership stakes
Rights offering example:
Someone that now owns 5% of the stock is granted the right to buy ___ of the new shares offered. Since the shares are offered at a ____, it is likely that virtually all the new shares will be sold. If a particular shareholder does not want to buy more shares, they can ____
5%
Big discount
Sell their rights to someone else
SEC registration of securities (stocks and/or bonds) for an offering to be made on a continuous or delayed basis in the future
Shelf registration
Each stock has a ticker ___ for identification when trading stocks. Tickers are between __ and __ characters long
Symbol
1-5
The latest trade price for the stock
Last Trade
The highest price anyone else is bidding to buy the stock from you
Bid Price
The lowest price anyone else is asking to sell the stock to you
Ask Price
52-week range indicates the range of the ___ over the past year, adjusted for ___ if any
Stock price
Stock splits
Dividend is the most recent ____ paid, usually expressed on an ___ basis
Cash dividend
Annualized
Yield Percentage is the dividend yield equal to the ___ as a percentage of the _____
Annual dividend as a percentage of the current stock price
The price-to-earnings ratio is equal to the ____ by latest 12-month reporting ____
Current stock price dividend
Earnings per share
The forward P/E is the _____ divided by the ___ of next year’s ____ by Wall Street analysis
Current price divided by the consensus forecast of next year’s earnings per share
Market capitalization measures the ________, equal to ____ times the ____
Total market value of all the stock outstanding, equal to share price times the number of shares outstanding
The trading volume for the day is the _____ traded
Number of shares
When investing, think about whether a stock is reasonably priced based on its ____ fundamentals, such as expected _____ and ____, not whether the share price is $10 or $100
per-share
Future earnings per share and book value per share
Measures how prices for stocks as a group (or on average) are behaving
Stock market indexes
The Dow Jones Industrial Average (DJIA) first published in ____ in the Wall Street Journal, includes __ mature, well-established companies
1896
30
The DJIA average is calculated by adding up the _____ and then dividing by a number called the ____
Prices of all 30 stocks divided by the divisor
The divisor changes only when there are ____ or changes in the ____
Stock splits or changes in the composition of the index
Since the DJIA includes only 30 stocks, and uses a ____ rather than a ____ weighting scheme, it is rarely if ever used to evaluate the performance of professional investors
Price-based rather than market value-based
Standard and Poor’s 500 (S&P 500) is an index that includes 500 of the ______. The average is weighted by market capitalization, or the ___________
Largest company stocks in the U.S. market
Total market value of the company’s stock (stock price times number of shares outstanding)
The S&P 500 is often used as a benchmark for ______ for both ___ and ___ investors; if your investment return exceeds the return on the S&P 500, you are said to have ____
Investment performance for both professional and individual investors
“Beaten the market”
NASDAQ Composite is a ____ of stocks there are listed on the NASDAQ system. It is weighted more toward ___ stocks than the DJIA or S&P 500
Value-weighted index
Technology
Russell 2000 is the _____ index of 2000 ____ company stocks
Value-weighted
Relatively small
Over the past 90 years in the United States, _____ investments earned higher returns than ____ investments, which in turn earned higher returns than _____
Common stock investments
Long-term Treasury Bond
Short-term Treasury Bills
Over 1928-2017, the ____ average total return on the S&P 500 stock index, including both dividends and capital gains and losses, was ___%. The highest annual return was ____ in ___ and the lowest annual return was ____ in ___
Arithmetic
11.53%
Highest: 52.56% in 1954
Lowest: -43.84% in 1931
Stock valuation is based upon the concept of ____ which depends on (1) ____ and (2) ____
Present value
Depends on (1) the future cash flows from the investment and (2) the discount (interest) rate
Present value formula for a single expected cash flow to be received in T years at a discount rate of R is
PV = E(Ct)/(1+r)^T
The value of the stock today is equal to the _____ of the ____ that the investor receives from owning the stock
Present value of the cash flows
If ___ goes up, ___ goes up. If __ goes up, __ goes down
Ct goes up, PV goes up
R goes up, PV goes down
Equity discount rate = r = _____ + _____
Treasury Bond Interest Rate + Stock Market Risk Premium
_____ cash flows increase PV, and a ____ reduces PV
Higher future expected
Higher discount rate
Investors receive cash flows from stocks primarily in the form of ___ and ___. The ability of companies to pay dividends and buy back stock in the future largely depends on ____. If the market expects improved ____, this suggest companies will be able to distribute more ____ through ____ now, and/or have more money available to ____, producing more ___ down the road. So, expectations of ______ lead to higher ____
Cash dividends and share repurchases
Corporate profits
Earnings growth
More cash to stockholders through higher dividends now
More money available to reinvest in their business, producing more dividends down the road
So, expectations of higher earnings growth lead to higher stock prices
We need a discount rate for stock market investments. Stock market investing is risky, so the _____ will be higher than for a relatively safe investment like a Treasury Bill or Treasury Bond. The equity discount rate can be expressed the the sum of the risk-free Treasury Bill ___ and a ___ for bearing the risk off tock investing
Equity discount rate
Interest rate and a premium
Equity discount rate = r = ______ + ______
Treasury Bill Interest Rate + Stock Market Risk Premium
What causes the stock market to go up or down which causes investors to revise their expectations of future corporate profits and the equity discount rate? (4 Factors):
- Expectations of future economic growth
- Interest Rates
- Inflation
- Risk Perception
Rational, risk-averse investors will always demand a higher return on ___ than on ___, because the ____ is a riskier investment than ____. So the risk premium will be ___.
From stock market history, a reasonable value for the risk premium is ____ per year
Stocks than on Treasury Bills, because the stock market is a riskier investment than Treasury Bills
Risk premium will be positive
6-7% per year
The precise value of the risk premium is ____, and presumably changes over time with ____
Unobservable
Economic conditions
From our present value equation, all else equal, if the discount rate r goes up, the _______ falls
Value of the stock
Most economists estimate that the long-term growth potential for U.S. GDP, adjusted for inflation, is about ___ per year. Long term economic growth comes from _____ and _____. Of course, the economy is subject to cycles of ___ and ___ over time
2-3%
Improving productivity and increasing population
Cycles of expansion and contraction (recession)
Corporate profits are highly ____, ____ faster than GDP in an expansion and ___ faster than GDP in a recession
Cyclical
Rising
Falling
The best time to invest in stocks has been when the economy is in ___, but starts to show signs of ____
Recession
Recovery
Interest rates are generally ___ during recessions, and often ____ during the beginning of a recovery
Low
Stay low
GDP measures ___, which includes both ____ and the costs of ____
Total output
Business profits and the costs of production
_____ increases stock prices but _____ do not
Higher profits
Higher production costs
If the economy is already doing well, and unemployment is ___, a further increase in GDP can lead to ______, which is not so good for ___
Low
Sharply higher wages
Stocks
_____ may rise if there is low _____ and workers are forced to put in a lot of overtime
Labor costs
Unemployment
If unemployment is very low, additional ____ in GDP often lead to higher _____, which is ___ for stocks
Increases
Interest Rates
Bad
If the economy is very ___ and unemployment is already very ___, a somewhat weaker economy is ___ for stocks
Strong
Low
Often good
A weaker economy can lead to ___ interest rates, and less ____ on wages and raw material prices
Lower
Upward pressure
Keep in mind that stock prices depend on ____ and ____, not just on how the economy is doing overall
Corporate profits and interest rates
In summary, an indication that the economy is _____ is good for stocks. But if unemployment is already ___ and the economy is running close to ____, further ___ in GDP are ___ for stocks, because they lead to ___ and ___
Coming out of a recession
Low
Full Capacity
Increases
Less positive
Upward wage pressure and higher interest rates
Interest rates affect the _____
Equity discount rate
___ interest rates lead investors to demand a higher _____, since bond and stocks each compete for _____
Higher
Equity discount rate
Investment (investors) dollars
Higher interest rates also directly reduce ___ and ___ for many corporations
Sales and profits
Suppose the interest rate on Treasury Bills is 4% and the stock market risk premium is 5%, so r =
If the T-Bill rate jumps to 7%, will investors still be happy with the above (r) return on stocks? ___ because there is ___ that risk has ____
Assuming that risk and risk premium stay relatively constant, a 3% higher Treasury Bill rate increases r by __, from __ to __ in this example
4% + 5% = 9%
9%
It is highly unlikely investors will now accept only a 2% stock market risk premium if there is no indication that risk has declined
Increases by 3%, from 9% to 12%
Holding all else constant, a higher r ___ stock prices, because stock prices are ____ values
Reduces
Present
With interest rates up, investors ___ stocks in order to ____ to ___ paying the ____, and this selling pressure ___ stock prices
Sell stocks
Get cash to buy bonds paying the higher interest rates
Reduces stock prices
Stock prices ___ far enough so that the market regards ___ and ___ as ___ attractive investments once again
From this example, we expect ____ relation between interest rates and stock prices
Fall
Stocks and bonds as equally attractive
Inverse
Historically there is ___ relation between stock ____ and Treasury ____, though the relationship has broken down over the past decade
Inverse relation between stock valuations and Treasury interest rates
Higher interest rates also directly ___ for many corporations. For companies that borrow from banks or from the bond market, higher interest rates increase the cost of ___. Also, companies that sell “big ticket” items such as houses, cars, and business equipment are ___, because their customers often need to ___ their purchases by ____.
To the extent that higher interest rates reduce ___, stock prices ___ as a result
Reduce profits
New borrowings
Hurt
Finance their purchases by borrowing
Higher interest rates reduce EARNINGS, stock prices SUFFER as a result
Higher expected inflation has been ____ for stocks historically. In general, when inflation is high, ____ and ____ ratios are low. Investors appear to place relatively ____ on stocks, relative to earnings and dividends, when inflation is ___. So, if expected inflation rises, stock values typically ___
Bad news
Price-earnings and Price-Dividend ratios are low
LOW VALUATIONS when inflation is HIGH
If expected inflation rises, stock values typically FALL
Higher inflation produces higher ____. Higher inflation reduces ____ from lending money, so to prevent a loss in purchasing power, individual savers demand ____ as inflation increases
Interest rates
Real returns
Higher interest rates
Higher inflation increases the odds of ____, ____, and ____
Political instability, government regulation, and price controls
Higher inflation often induces the Fed to tighten ___, increasing ____
Tighten CREDIT, increasing REAL INTEREST RATES
Company X sells cat litter and has $500 million of short-term debt. Company Y sells recreational boats and has no debt. If interest rates unexpectedly increase, which stock would be expected to be hurt the most, or can you tell? Explain.
Company Y stock would hurt the most because recreational boats are more expensive so they are investments and not necessities whereas cat owners need cat litter
Higher inflation increases personal ____ on ____ returns
Taxes on real investment returns
If inflation gets too high, the Federal Reserve Board can be expected to ___ credit to ___ the economy and reduce _____, raising interest rates by ____ the increase in ____
TIGHTEN credit to SLOW DOWN the economy and reduce INFLATIONARY PRESSURES, raising interest rates BY EVEN MORE THAN the increase in INFLATION
If the Fed attempts to ___ inflation, you end up with an economy with ___ interest rates and ___ growth for a while
Restrain
HIGH interest rates and LOW growth
Until inflation is finally ___, or at least until investors believe inflation is _____, you have a __ economic environment for stocks
Reduced
Under control
Bad
If interest rates rise by the same amount as the increase in inflation, ____ after taxes ____
REAL RETURN after taxes DECLINE
If consumer prices double over a decade, and the value of your stock portfolio also doubles, you might think you are no better or worse off than before, but the tax on the _____ makes you ___ off
Capital gain
Worse
The more inflation, the more investors get taxed on ____, and that doesn’t make investors happy
“Phantom” inflation profits
People are not willing to pay a high price for ___ if taxes take away much of their ____ power. They might just spend their money on ____ or ____ rather than ____, placing ____ on stock prices
Stocks
Purchasing power
A new car or vacation rather than invest in stocks, placing DOWNWARD PRESSURE on stock prices
Investor perceptions of stock market risk affect the ____, and hence the ____
STOCK MARKET PREMIUM and hence the DISCOUNT RATE
If stocks are perceived to be ___ than before, perhaps because of wars around the world, or economic or political instability, r will ___, ___ stock prices
Riskier
R will INCREASE, REDUCING stock prices
If the market feels that economy is very solid, with little risk of wars or recession, r will ___, ___ stock prices
r will FALL, INCREASING stock prices
An increase in stock prices despite higher interest rates means either the outlook for ____ has improved, or stocks are perceived to be ___ than they were before
Future earnings
Less risky
Stocks perform best in a “____” economy (not too ___, not too ___), where growth is ____, inflation is ___, and the U.S. dollar is ___ or ___ against other currencies
“Goldilocks” economy (not too HOT, not too COLD)
Growth is MODERATE, inflation is LOW, and the U.S. dollar is STRONG or STABLE
Often the highest stock returns are achieved when the economy is ____, and many companies are _____, but there is signs of a _____
Still in a recession
Suffering losses
Recovery
Stocks have also done well when inflation is ___ but starts to ___
HIGH but starts to DECLINE
Stock prices are susceptible to a ___ or “___” when the economy is currently doing well but there are signs of ____ or a possible ____
Fall or “correction”
Signs of HIGHER INFLATION or a possible RECESSION
What does Warren Buffet Wisdom “If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?” mean?
In regards to the stock market.
You want lower prices of course, but in regards to the stock market think of CATTLE as STOCK, as ranchers do. If you plan to buy stock throughout your life, but don’t own any now, you might want stock prices to FALL, because you can buy at cheaper prices than before. If you already own stocks, but don’t plan to buy any more, perhaps because you are retied, you are more like the cattle producer slowly reducing the size of the hear. You are selling off stock over time to support yourself. You definitely want to see stock high prices, because you are selling and not buying
Most of us are somewhere in the middle, owning some stocks but also planning to buy more over time. Younger investors with relatively little stock wealth benefit more from lower stock prices than older investors with big stock portfolios
If stock prices fall because of things that reduce _______, like wars, higher foreign oil prices, higher taxes, and natural disasters, that is ___ for any stock investor. But other causes of _____^ prices, things that increase the equity discount rate, can be ___ for potential stock buyers. These include higher ____, higher ___, and higher investor ____.
Stock prices
Bad
Reducing stock prices
Good
Higher interest rates, higher inflation, and higher investor risk aversion
With a (higher or lower?) equity discount rate, you can expect (higher or lower?) stock market returns in the future
Higher
Higher
Generally, it is unwise to attempt to _____, which means making ___ bets on which way ___ prices are heading
“Time the market”
Short term
Stock
The following indicators have been used to predict stock market ____ with at least some success (3):
Returns
- Price/Earnings ratio
- CAPE
- Dividend Yield
When the P/E on the overall stock market has been unusually ___, future stock returns have tended to be ___ average
High
Below average
The 90-year historical average P/E on the market is around ___. As of November 30, 2018, the P/E on the S&P 500 index was around ___. So, perhaps it is more likely that the market P/E will __ than __ in the future
17
21.7
More likely to FALL than RISE
CAPE is calculated by dividing the ___ of the S&P 500 index by the trailing ____ of ____ on the index
Each annual earnings figure over the past 10 years is converted to current dollars using the ___, and then ___.
CURRENT PRICE of the S&P 500 index by the trailing trailing 10-YEAR AVERAGE of REAL (INFLATION-ADJUSTED) EARNINGS on the index
Consumer Price Index (CPI), and then AVERAGED
The CAPE is less subject to temporary earnings fluctuations than the ____, and has been shown to be ___ related to future stock market returns
“Regular” P/E
Inversely related
When the dividend yield on the market is ___, future ___ have tended to be ____
High
Future stock returns
Above average
The average dividend yield over December 1928 through December 2016 inclusive is ___%, while the average over December 1990 through December 2016 incisive is ____
- 83%
2. 08%
The price of the stock (or stock index) is in the ___ of the equation for the dividend yield, so if stock prices fall dramatically relative to the dividends paid, the dividend yield ____, and stock prices can be thought of as being “____”
However, this indicator has not worked well lately, as more companies ____ rather than ____ when they have extra cash. So, the dividend yield indicator may not work so well in the future
Denominator
Increases
“Undervalued”
REPURCHASE STOCK rather than PAY DIVIDENDS
None of the stock market valuation indicators are ____. All they can do is provide a hint of whether the stock market is ____ or ____. If you read the newspaper and notice that the P/E ratio on the S&P 500 index is 30, and the dividend yield on the S&P 500 is reaching historic lows, be very cautious about throwing all your money into the market right away. These are signs that you might be buying at a ____. That said, if you have a _____ until spending the fruits of your investments, don’t wait forever to start buying stocks, always hoping that prices will fall. Just invest ___ and ___ into the market if stock prices appear very ___ relative to fundamentals
Foolproof
Undervalued or Overvalued
Market peak
Long time horizon
Gradually and Cautiously
High
Stocks are ___ investments. Neither dividends nor capital gains are at all ____. Investing in _____, rather than investing in ____ that track the overall stock market, can be particularly ____
Risky
Certain
INDIVIDUAL STOCKS, rather than investing in WELL-DIVERSIFIED MUTUAL FUNDS
Risky
When investing in an individual stock, both the risk of the stock in ____ and the risk of the stock in the ___ of a ___ are important to know about
Isolation
Context of a Portfolio
The total risk of a stock can be divided into two components, _____ risk and _____ risk
Market Risk and Firm-Specific Risk
Market risk or ____ risk is the component of a stock’s risk that is related to the stock market as ___
Systematic
As a Whole
Market risk is the risk associated with _____, including __ and __ in GDP, ____, ____, and ____
General economic conditions
Including Ups and Downs in GDP, interest rates, inflation, and exchange rates
The market risk of an individual stock is measured by its ___.
___ measures the general sensitivity of the ___ on a stock to the ____ on the overall ____
The (value-weighted) average stock has a __^ of ___
Beta
Beta
RETURN on a stock to the RETURN on the overall STOCK MARKET
Beta of ONE (1)
If a stock market has a beta of 1, it tends to move __ and __ ____ with the market in percentage terms
A beta above 1 indicates a ____, which tends to go __ by more than ___% when the market goes ___ by 1%
UP and DOWN, one-for-one
Cyclical stock
UP by more than 1%, when the market goes UP by 1%
Stocks with high betas have ___ market risk, and are ____ to stock market fluctuations
High market risk
Very sensitive
High beta companies often produce things where purchase can be ___ if economic times are ___, like manufacturers of ______
POSTPONED if economic times are BAD
Airplanes, semiconductor equipment, autos, or houses
A beta below 1 indicates a _____ stock, which tends to go __ by less than 1% when the market goes __ by 1%
Defensive companies produce things considered _____, like electric power, food, toothpaste, and drugs and beverages
Defensive stock
Up
Up
Day-to-day necessities
It is very rare to have a stock with a ___ beta, a stock which tends to go __ when the overall market falls
Negative
Up
Diversifying or dividing your investment among many individual stocks does not ___ beta (market risk): the beta of a portfolio is just the ____ of individual betas
So, if you have 2/3 of your money in a stock with a beta of 0.75, and 1/3 of your money in a stock with a beta of 1.5, then the beta for the portfolio is ___
Reduce
Weighted-Average
1 (Average of 0.75 at 2/3 and 0.75 at 1/3)
It is important to remember that beta only measures a ____, not an ______. A stock with a beta of 2 will tend to fall by about 4% if the S&P 500 falls by __, but the actual return on the stock could be much higher or lower on any given day
TENDENCY, not an EXACT RELATIONSHIP
2%
Why is beta important for investors (2)?
- Portfolios concentrated in high beta stocks tend to be riskier than portfolios concentrated in low beta stocks
- Depending on your market forecast, you may want to tilt your portfolio toward either cyclical (high beta) or defense (low beta) stocks
Portfolios concentrated in ___ beta stocks tend to be riskier than portfolios concentrated in ___ beta stocks
Depending on your market forecast, you may want to tilt your portfolio toward either ___ or ___ stocks
High
Low
Cyclical (high beta) or Defensive (low beta)
Suppose the economy is currently in bad shape with high unemployment. If you expect a major economic recovery, and thus a rally in the stock market, investing in an electric utility stock will not provide much “bang for your buck”, because electric utility stocks have ___ betas. Intuitively, the demand for emetic power will not ___ all that much when the economy expands
The profits of a hotel company or an airplane, appliance or auto manufacturer will be much more ___ to economic conditions, and hence the stock price of Boeing will tend to ___ more rapidly if the economy and stock market recover
Low
Increase
Sensitive
Rise
Firm-specific risk is the performance of firm’s _____, ___ or ___ in research and development (R&D), technological evolution, and changing consumer tastes for specific products
Management
Success or Failure
Diversification does ___ the impact of ____ risk on the risk of the overall portfolio
Reduce
Firm-specific
Firm-specific risk is there six associated with ___ events, rather than the risk associated with the ____
Firm-Specific events rather than Stock Market as a whole
Diversification reduces ___ without sacrificing expected ___, providing a better tradeoff between ___ and ___
Total risk
Return
Risk and expected return
With diversification, investors can hold stocks with _____, but still have a low-risk portfolio, because the individual ____ risks largely ___ each other
Substantial firm-specific risks
Firm-Specific risks
Offset
Individuals probably need at least __ stocks for adequate diversification within the U.S. stock market. It is best to hold more than ___ different stocks. If you diversify among ___ or more stocks, you will be able to reduce _____ to a very low level
30
50
50 or more
Firm-specific risk
While brokerage ____ make it very costly for someone with $10,000 to invest to hold 30 or 50 different individual stocks, individuals can obtain a ____ diversified portfolio by investing in ____
Commissions
Highly
Mutual funds
To stay well diversified, individuals should not keep more than ____ of their portfolio in any one industry. Without special expertise, do not invest too much in stocks in the ___ or the ___
Also, do not limit a portfolio to _____ stocks
For additional diversification benefits, include a mix of __ stocks, __ stocks, and ___ stocks, as well as __ and __ in a portfolio
10-15%
Industry you work in or region you live in
“Famous-name” U.S. stocks
Small, large, and international stocks, as well as bonds and real estate
To evaluate the attractiveness of a particular investment, think about how returns from that investment interact with returns from _________. In other words, think about how returns from a __ investment will __ returns from the __ investments you have. Think of your ____, or the present value of future labor income, as on of your ____ investments
Other investments already in the portfolio
NEW investment will BALANCE returns from the EXISTING investments
Think of your HUMAN CAPITAL, as one of your EXISTING investments
Diversification Example:
My current portfolio includes Alphabet, Microsoft, and Apple. If I have enough money to buy another stock, should I purchase Facebook or ExxonMobil? Why?
Probably ExxonMobil
Your portfolio is heavily concentrated in technology stocks, so spread your money out across different industries
Diversification Example:
Suppose you work for the local electric utility company, and are thinking of buying your company’s stock. The company has a good earnings history, and fluctuations in the stock price have been relatively small over time. Is this a good investment? Why?
Probably not
If there is a major catastrophe at the company, such as a new invention making solar energy much cheaper than it is now, you will likely both lose money on your investment and lose your job. Your most valuable investment is often your own human capital.
All else equal, choose investments that tend to go __ in situations when your _____ goes down in value
Up in value
Human capital goes down in value
Diversifying internationally can provide the same benefits as ___ diversification, lowering ___ without sacrificing ____
Domestic
Lowering RISK without sacrificing EXPECTED RETURNS
Historically, international stock returns have been comparable with domestic returns, though have ______ over the ____
Fared well over the past decade
____ markets like South Africa and Brazil are generally more risky than ___ markets like Germany
Emerging
Established
Over the ten years ending 6/30/2017, FTSE Developed Asia Pacific index earned ___/year, FTSE Europe earned ___/year, and the FTSE Emerging Markets Index earned ___/year. The S&P 500 earned ____/year over the same period
Asia Pacific: 2.21%
Europe: 0.81%
Emerging markets: 1.58%
S&P 500: 7.18%
For individual countries, returns have been highly ____, with many returns over ___ or below ___ in a single year
Favorable
Over 100% or below -50%
Political risk includes outright ____ and ____ of foreign investors
Outright nationalizations and discriminatory treatment
Dollar returns from international investments depend both on the local _____ and the movement of the ____
Currency return and movement of the exchange rate
If the U.S. dollar depreciates against the currency in which you have invested, your dollar return is ____ than the local currency system
Higher
American Depository Receipts (ADRs) represent a certificate of ownership in a _____ that is held in a ___
All dividends are paid in ___ and prices are quoted in ___
The cost of administering the ADR are borne by the shareholder through ________
Foreign firm that is held in a foreign bank
Dollars
Dollars
Slightly-reduced dividend payments
Numerous ADRs trade on the ___ and on ___
ADRs that are listed on the ___, ___, or ___ must meet the listing requirements of their ____, and must provide _____ that are consistent with Generally Accepted Account Principles (GAAP) in the U.S.
NYSE and NASDAQ
NYSE, AMEX, or NASDAQ
Exchange
Financial statements
Many U.S. multinational corporations derive a large percentage of their revenues and earnings from ___ or ___ operations. Thus, these companies participate directly in the performance of _____ economics. Prominent examples include Microsoft, Coca-Cola, Caterpillar, Alphabet, and Boeing
Exports or Overseas operations
Overseas
Which countries or regions should you invest in?
Factors to consider include the ____ of the country, ____ trends, ____ achievement, ___ and ___ stability, and ___ levels
- LONG-TERM GROWTH RATE of the country
- DEMOGRAPHIC trends
- EDUCATIONAL achievement
- POLITICAL and CURRENCY stability
- VALUATION levels
Many countries levy income taxes on ___ and ___ paid to ___ investors. The withholding rate is often __% or __%. The amount of foreign taxes paid is recorded on the annual ____ fro your broker or mutual fund company. Investors receive a tax credit for foreign taxes paid on their _____. If the amount of the credit is less than ___ for single taxpayers, no additional forms (Form 1116) need to be filled out. If you invest in international stocks or bonds in a tax-deferred retirement account, like a 401(k) or IRA, you ______ credit for those foreign taxes paid
DIVIDENDS and INTEREST paid to FOREIGN Investors
10% or 15%
1099 tax form
1040 Tax return
$300
You NEVER receive credit
Real Estate Investment Trusts (REITs) are publicly traded companies that ____ and typically ____ commercial real estate. They trade on stock exchanges like regular common stocks. There are also ___ that buy REITS. REITS generally ____ in _____ of the commercial real estate market, like shopping center, apartments, industrial, office, hotels, and health care
BUY and typically MANAGE
Mutual funds
SPECIALIZE in PARTICULAR SECTOR
REITs must distribute at least ____ of their earnings as ___ to ___, but then can deduct their _____ paid from their ______ in computing corporate income taxes
All earnings (or even more) paid as ____ = no ____
90% of their earnings as DIVIDENDS to SHAREHOLDERS
Deduct their DIVIDENDS paid from their INCOME
All earnings paid as DIVIDENDS = NO CORPORATE INCOME TAXES
REIT dividends do not qualify for the ____ rates that apply to dividends on regular ______, but starting in 2018, REIT investors can deduct ___ of REITs dividends from their ____ income, like other “pass-through” businesses that don’t pay ___
Low personal tax rates
Common stocks
20%
Taxable
Corporate tax
REITs tend to have ___ betas and standard deviations, and as such have ___ risk than the average stock
Over the past 30 years, REITs have earned solid ____ returns, and provide _____ benefits when combined with a _____. A key indicator for REITs is their ______, if the ____^ is now well below its historical average, it may be a time to ___
Low
Lower
Risk-adjusted
Diversification
Stock portfolio
Dividend yield
Dividend yield
Sell
Disadvantages of investing in gold:
Gold provides ____, it is not used to ____ while you are ____. Also, gold must be ___ and possibly ____. It isn’t free to store gold safely, unlike storage for a __ or __ or a ___
On the plus side, gold provides an _______
Gold provides NO INCOME, it is not used to MAKE OTHER THINGS while you are HOLDING IT
Gold must be STORED and possibly INSURED
It isn’t free to store gold safely, unlike storage for a STOCK or BOND or a BANK ACCOUNT
Gold provides an INFLATION HEDGE
Since gold is a ___ asset, as opposed to a ___ asset like a corporate bond, its value will tend to ___ with inflation
Often, its price will ____ in anticipation of higher inflation. Since bond and stock prices both tend to ___ when there is anticipation of higher inflation, gold can provide ____ within a portfolio
Real
Nominal
Increase
Increase
Fall
Diversification benefits
Gold protects against ____. If the U.S. financial system were to fall into a complete panic, with hyperinflation, bankruptcies, and government takeovers of industries, stocks and bonds would ___ sharply in price. In such a scenario, a ___ asset like gold that is easy to conceal and transport (a high value per unit weight and volume) would be a good investment to have. Gold is perhaps the ___ investment of all if your country is invaded, ruled by a totalitarian government, or falls into anarchy
Gold protects against POLITICAL RISK
Fall
“Real”
Gold is perhaps the BEST investment
It is reasonable to expect that the price of gold is ____ by the demands of dictators abroad and their unfortunate subjects. In countries with low ___ and relatively low ___ risk, gold should be a relatively ___ component of your portfolio
Inflated
Political
Inflation
Small
Trading stocks generally requires a _____. For retail investors, there are two informal categories of brokers, ____ brokers, such as Merrill Lynch, Raymond James, or Morgan Stanley, or ____ brokers, such as Charles Schwab, TD Ameritrade, E*Trad, or Fidelity. Their costs and services can differ dramatically
Stockbroker
Full-service brokers
Discount brokers
Full-Service brokers provide _____ and _____.
Some full-service brokers have designations such as Certified Financial Planner (CFP). Full service brokers also often have ___ and ___ specialists on staff to assist clients when needed
Full service brokerages have research departments that employ financial analysts. These analysts recommend ___ and __ of specific stocks to the firms’ clients based on their ___. For active traders, brokers will notify clients when one for their analysts _____ on a stock, before making the changed recommendation public
Provide GENERAL INVESTMENT ADVICE and SPECIFIC STOCK RECOMMENDATIONS
Sell mutual funds usually load in ____ accounts. Many mutual funds are available directly through the ____ company, but others are sold only through ______ like full-service brokers
Commission-based
Mutual fund
Investment advisors
_____ brokers charge much higher trading commissions than ____ brokers. Full service commissions are not _____ and are _____ between the customer and broker, but can exceed __% of the dollar value for trades under ____. A trade of 500 shares at $20 per share could easily cost more than $200 at a ___ broker
TRADITIONAL FULL-SERVICE brokers charge much higher trading commissions than DISCOUNT brokers
Full service commissions are not PUBLICIZED and are NEGOTIABLE between the customer and broker, but can EXCEED 2% of the dollar value for trades UNDER $10,000
Full-service
Many people are reluctant to pay for investing advice on a “____” basis, so as an alternative, full service brokers that provide advice must get compensated in other ways. Unfortunately, compensating brokers solely through commissions creates an incentive to recommend ____. The more you trade, the more that full-service brokers earn in ____, if if buying and holding is a _____
“By the hour”
Active trading
Commissions
Better long-term strategy
As a response to potential “churning” problems, there is an industry trend toward ______ accounts that do not charge any ____ to trade, or charge much ____
But with an asset management account, the customer pays an ________ of __% or ___. There is a _____ fee on these accounts, usually over ___ per year
There is an industry trend toward ASSET MANAGEMENT accounts that DO NOT charge any COMMISSIONS to trade, or charge much LOWER COMMISSIONS
The customer pays an ANNUAL MANAGEMENT FEE of 1% or MORE
There is a HEFTY MINIMUM fee on these accounts, usually OVER $1000 per year
Features of Discount Brokers (3):
- Little or no personal investment advice
- No propriety research
- Commissions
Some discount brokers have websites and/or newsletters that provide ____, but they do not get ____
Provide GENERAL INVESTMENT ADVICE, but why do not get PERSONAL
Discount brokers do not have _____. Some offer ____ from the Wall Street analysis, with ____ available for a fee
Research staffs
Summary research reports
Detailed reports
For internet trading, commissions for discount brokers range from about $- online per trade, and typically the commission is good for up to __-__ shares at any ____. The commission is higher for orders by ___
$5-$10
1000-5000 shares at any PRICE PER SHARE
Commission is higher for orders by PHONE
In summary, only rather ____ individuals should consider using a full-service broker. Full service brokers can provide access to attractive ____ that may not be available to customers of ____. Full service brokers provide ____ updates to their best customers in a timely manner, allowing them to ___ stocks that have been ___ before the stock price fully adjusts to a _____. Realistically, you need to have a significant amount of money available to invest in a single stock, like ____ or more, to make such short-term trading pay off. Finally, full service brokers provide more services to the sophisticated, high net worth investor, like ____ and _____
Wealthy
Initial Public Offerings (IPOs)
Discount brokers
Stock research updates
Buy
Upgraded
Higher level
$25,000
Personalized Tax and Estate Planning
Stock exchanges allow investors to trade stocks ____. By providing a forum and standardized mechanisms for trading, trading is more ____. ____ trading makes investments more ____ in the first place, so corporations and government scan raise money on more ___ terms. If an investor knows that there is a functioning financial market with willing buyers and sellers for a particular stock, that stock is a more ___ investment. Without financial markets, it is difficult for corporations to find willing ___, because it is difficult for ___ to __ their positions
Among themselves
Convenient
Convenient trading
Desirable
Favorable
Desirable
Buyers of their stocks
Buyers to LIQUIDATE
Another important function of stock exchanges is to _____. Without an actively traded market for a security, it is difficult to establish its ____. Investors unsure of the ____ of their stock are ___ likely to want to trade, for the fear of ____
Establish prices
Fair value
Value
Less
Getting ripped off
Financial market prices represent a ____ of the investing public
Consensus opinion
New York Stock Exchange (NYSE) lists most of the __, ___ companies in the U.S. including GE, Exxon, Ford, and JPMorgan Chase.
On the NYSE, the vast majority of stock holders are handled ______, but there is also a designated ____ firm that stands ready to buy and sell shares from the public and maintain an ____ market. A stock listed on the NYSE can trade ____, not just on the NYSE
Largest, well-established
Electronically
Market maker (DMM)
Orderly
Anywhere
National Association of Securities Dealers Automated Quotation (NASDAQ) trade is handled _____, where multiple ___ in the stock submit and continually update prices at which they are willing to buy and sell. NASDAQ stocks include Microsoft, Intel, and Apple. A stock listed on the NASDAQ can trade ____, not just trade on the NASDAQ
Electronically
Dealers
Anywhere
CBOE is a leading ______ operator, handling a considerable percentage of trading in both ___ and ___ listed stocks
Electronic exchange
NYSE and NASDAQ
Brokers have a fiduciary duty to obtain the best ___ for their customer’s ____. Brokers will thus search ______ (and other venues that are not exchanges, such as dark pools) to find the ____ for their clients
Execution
Orders
Across exchanges
Best execution
Over-The-Counter (OTC) are ____, ____ stocks that do not qualify for being listed on the ____ or on ___ and are traded ____ among ___ around the country
These stocks are often not very ____, or easy to sell on ____. Some are in bankruptcy and have been delisted from major exchanges. There are some completely legitimate foreign companies that only trade over-the-counter here, because they do not want to bear the ______ for trading on the NYSE or NASDAQ.
Small, obscure
NYSE or on NASDAQ
Over-the-Counter
Dealers
Liquid
Short notice
Costs and disclosure requirements
Regular trading hours are between ___ and ___ eastern time ___ through Friday.
Stocks are traded using a unique ____
9:30 a.m. and 4:00 p.m. Monday through Friday
Ticker symbol
When you connect online to your broker, you will be quoted a ___ and a ___. The ___ price is the highest price that anyone is bidding to buy your shares. In other words, the bid is the most anyone is willing to pay to ______. The ___ price is the lowest price that anyone is asking to sell shares. In other worse, the ask price is the lowest price anyone is charging to _____. The ___ price is always higher than the ___ price. The difference between the two is known as the ____
Bid price and an Ask price
Bid price
Buy shares from you
Ask price
Sell shares to you
Ask price is always higher than the Bid price
Difference between the two is known as the BID-ASK SPREAD
You will also be quoted a ___ at the ask and ___ at the bid, which is the number of _____ to __ or __ at that ask or bid price. Except for extremely high-priced stocks, ___ is usually at least ____ shares.
Depth
Depth
Shares available to buy or sell
Depth is usually at least 100 shares
As an investor, you can submit orders to buy or sell in multiples of __ shares or _____, in odd lots of fewer than __ shares, or in __ lots of 150 or 236 shares. At most all brokers, commissions on odd or mixed lots are ____ on round lots, so you do not need to restrict yourself to suit a round lot order
100 shares or ROUND LOTS
200 shares or MIXED LOTS
Mixed and Round lots are the SAME
In general, large company stocks with high trading volume, low volatility, and a low degree of information asymmetry between insiders and outside investors will have ___ percentage bid-ask spreads and ___ depths. Small, infrequently traded stocks that are not closely followed by Wall Street are ___ liquid
LOW percentage spreads and HIGH depths
Less
A market order is an order to buy or sell _____ at the best _____. Most small market buy orders are executed at the quoted __ price. Most market sell orders are executed at the quoted __ price. Sometimes market orders are executed at a price better than the current quote, called ______.
Immediately
Available price
Ask
Bid
Price improvement
Suppose Kroger stock has a bid price of 20, and an ask price of 20.07. Depth is 500 shares at the ask, and 800 at the bid. If you buy up to 500 shares at the market, you will pay ____ per share. If you sell up to 800 shares at the market, you will get ___ per share. If you want to buy more than 500 shares, you will probably pay more than ____ for the additional shares above ___
$20.07 per share
$20 per share
$20.07
500
A large market order can have a big “____”, because it signals the trader has ___ and is ___ to trade
“Price impact”
Information
Eager
A limit order is an order to buy or sell a ____ of shares at a certain _____, known as the _____
Particular number
Price or better
Limit price
Limit orders are either _____ or ____, sometimes called ___ or ___, or displayed
Immediate or Cancel
Fill or Kill
Immediate or Cancel (IOC) orders are either _____, at least in part, or immediately ____.
Immediately filled or immediately cancelled
Displayed orders that are not immediately filled remain ____ for ____. Displayed limit orders have __ and __ priority; they are executed before any other _______ to the other side of the trade, and are executed before any other _____ but that was submitted later
On the books for future execution
Price and Time priority
Order offering an inferior price
Order offering the same price
There are two types of displayed limit orders, a __ order, which is active for only the ____, and a _____ order, which lasts around ____, depending on the broker
Day order
Day the order is place
Good-till-cancelled order
60 days
The most important disadvantage to limit orders is that you may never _____
A second disadvantage is that if someone submits a market buy order for less than the number of shares you specify, the order is ____
Get your order filled
Only partially filled
You only have to pay one commission if your order is ____ within the same ____, but a second commission is charged if a ____ order is filled on a ___ day
FILLED within the same TRADING DAY
Good-Until-Canceled order is filled on a SUBSEQUENT day
To avoid partially filled limited orders, you can submit an ____ order, requiring that the order must be ____ or ____
However, ____ orders have “____” on the exchange, so might not be executed even if the stock falls below the ____ or goes above the ____
All-or-None order
Filled in total or not at all
All-or-None orders have “No standing”
Below the specified limit buy price or goes above the limit sell price
Brokers charge commissions on limit orders if the order is ______. If a trade never takes place, there is ____
At least partially filled
No commission
During the trading day, if an investor submits a limit buyer order at a price ___ the current ask price, then at least ___ of the order (the ask depth) will be filled ___ at the __ price.
With a limit order to sell ___ the current bid price, at least some of the order (the bid depth) will be filled immediately at the ___ price
These types of orders are sometimes called _____ order
Above
Some
Immediately at the ask price
Below
Bid
Marketable limit
With a market order, execution is ____, so you are sure that purchase or sale will ______ while market is open
Immediate
Be made within seconds
With a limit order, you can often get a ____ than with a market order, but have the uncertainty that ______, or you can’t buy as much as your wanted at the ___ price and end up paying extra ____
Better price
Your order may never get filled
Limit
Commissions
Submit a ___ order when you really want to buy or sell a small quantity in a hurry, when you think the price will go up quickly (if you are buying) or down quickly (if your are selling). Submit a ___ order when you are not as anxious to buy or sell, or when the spread is very wide
Market
Limit
As a practical matter, if you are eager to buy a stock that has a very wide spread, try submitting a ____ order at a price a little bit ___ the ask price
Limit buy
Below
The discount broker receives a “_____” to send the order to a particular dealer, and the dealer executes the order at a price that is _____ than available available on an exchange
“Payment for order flow”
Good or often slightly better
Why is the dealer willing to give a slightly better price to the retail investor, and also pay the discount broker for the order flow?
Dealers make money from buying at the bid and then selling at the higher ask price. But dealers lose money when they buy at the bid, and then the stock price drops, so the new ask falls below what they just paid.
Similarly, dealers lose money when they sell at the risk, and then the stock price rises to the new bid is above what they just received
The vast majority of retail investors using discount brokers are “____” investors, people that really do not have ____ about the true value of the stock. So dealers will give a slightly tigehter bid ask spread, and pay for order flow, to trade with (probably) ______
“Uninformed”
Information
Uniformed investors
A stop-loss order is an order to sell at the market if the ___ price reaches or falls below a particular ____ price. It is an order to “____” of the stock before your losses get too high, or your paper profit _____. Unless and until the _____ price of the stock reaches the ____ price, nothing happens and no ____ is paid to the ___
Bid
Stop-loss
“Bail out”
Disappears
Market
Stop-loss
Commission is paid to the broker
A stop-loss price is not a ____ price, but acts only as a ___ to ___ if the stock hits that price
Guaranteed
Trigger to sell
If you really can’t afford to have the price of a particular stock ______, put in a stop-loss order. Otherwise, don’t bother with them. You may end up selling a stock ____ that you really like for the _____. If you sell and then buy back the same stock later, you have paid ____ and ____. Selling stocks after a drop in price is usually a bad strategy for the ____ investor, unless fundamentals have taken a major turn for the worse. Placing stop-loss orders “____” the questionable strategy of selling after a price ___
Fall below a specific level
Prematurely
Long-term
Two extra commissions and bid-ask spreads
Long-term
“Automates”
Decline
If you place a market order when the stock exchange is closed, your trade will be executed at the __ price shortly after ___ eastern time. However, you are not guaranteed ____.
Open
9:30 a.m.
Any particular price
All orders submitted before ___ eastern time stocks should receive the ____ price if executed. The ___ price is a result of an auction process, and is the same for buyers and sellers; there is no ____ when trading at the open
9:15 a.m.
Opening
Opening
Bid-ask spread
Both the NYSE and NASDAQ have auctions at the close of trading each day, similar to the auction at the open of trading each day. Investors can specify that their order must be place in the ___ auction, either ____ or ____. Trades at the close do not pay a ____, as both buyers and sellers transact at the same ___ price
Closing
Market-on-close or Limit-on-close (MOC or LOC)
Bid-ask spread
Closing
Some brokers allow _____ trading for ___ investors. Individuals should be cautious about ____ trading, because liquidity is ___ for all but the ___ company stocks. Do not submit ___ orders for execution during extended-hours trading, only us ___ orders.
Extended-hours
Individual
Extended-hours
Poor
Largest
Limit
A limit order that is not displayed to market participants. These orders have time priority at same price
Hidden orders
A limit order that is partially displayed and partially hidden. The displayed portion is replenished when the displayed portion is executed. Also called an ‘___’ order
Reserve order
‘Iceberg’ order
An order that has a displayed limit price and a hidden ____ range (above for a buy order, below for a sell order)
Discretionary order
Discretionary
Regular brokerage accounts are often call _____, because all stock purchase must be paid for in ____
Cash accounts
Full with cash
If you have a specific kind of brokerage account called a ______, you are allowed to borrow a part of your investment from your broker
Margin account
Margin Account:
The Federal Reserve Board sets a maximum of ___% of the purchase price of a stock that can be borrowed, called the ____ requirement
Many brokers will set stricter limits than this, especially for “___” accounts, where the investor has only a few stocks in the account and as such is poorly ____
50%
Initial margin
“Concentrated”
Diversified
Investors must have at least $____ in account equity to buy on margin. Stocks selling for less than $__ per share cannot be bought on margin at most broekrs
$2000
$3
The ___ in your ___ account serve as collateral for a margin loan. Margin loans have no specified ____. The loan can be kept as long as maintenance margin requirements are ___
Securities
Margin
Maturity date
Satisfied
For large traders, the interest rate on a margin loan is usually a small markup of __% to __% over the ____ rate
1/2% to 2% over the CALL MONEY rate
The call money rate, published daily in the WSJ, is the rate banks charge to brokers to ____, and is usually a couple percentage points ___ the interest rate on Treasury Bills
Borrow money
Above
Margin interest rates vary from broker to broker, and usually varies based on the _____, with ____ getting lower rates
Small retail borrowers usually pay ____ the call money rate
If you want to buy stocks on margin frequently, find a broker that offers a ____
Size of the loan
Larger loans
Several points above
Low interest rate
For tax-payers that _____, margin loan interest is tax-deductible up to ____ for the year, where ____ is defined as interest, REIT ____, ___ income, and short-term _____
Itemize deductions
Investment income
Dividends
Annuity
Capital gains
Rate of return = ( _____ + ____ - ( ___ + ___) - _____ )/ ____
Rate of return =
( Ending value of stock + dividends - (Loan + Interest) - Intitial Equity Investment ) / Initial Equity Investment
_____ of stock = ending value of all ____
Ending value
Shares held
Initial Equity Investment =
Amount of your own money initially invested
According to FINRA industry regulations, the amount of equity in margin accounts must be at least __% of the current __ value of all stocks that are ‘___’ (owned) in the account but are usually at least ___% or ___%
25%
Market
‘Long’
30% or 35%
A maintenance margin requirement of __% is violated if the loan balance including ___ exceeds __% of the value of the ___ assets in the account
The first thing that most brokers will do is give the customer a ____, asking the customer to _____ into the account immediately to _____
35%
Interest
65%
Long
Margin call
Deposit more money
Pay back part of the loan
If a customer ignores a margin call, what happens?
The broker will sell stock and use the proceeds to repay the loan plus interest
They are permitted to sell any stock in your account without notification and might decide to sell a stock you would have rather kept and keep on your would have sold
Short selling is an investment strategy that earns a profit if the ___ price goes ___, not __. In order to be allowed to short sell a stock, you must have a ___ with your broker. To short sell, you first ____ shares from your broker, immediately ____ in the market, and then ____ at a later date to return ____
If the stock price goes ___, you can make a profit. If the price goes ___, you still must _____, and you ____.
Stock
Down
Up
Margin account
Borrow
Sell them
Buy them back
If the stock price goes DOWN, you can make a profit. If the price goes UP, you still must BUY BACK THE SHARES YOU BORROWED, and you LOSE MONEY
Short Sales:
Now (3):
Later (3):
Now:
- Borrow stock form your broker
- Sell it immediately
- Collect cash, which must stay with broker
Later:
- Buy stock in the market
- Pay cash to do so
- Return stock to your broker
Where does the broker get the stock to lend out in Short Sales? (4):
- Margin accounts of other investors at the broker
- Mutual funds
- Pension funds
- Other institutional investors
Brokers require an initial margin deposit of __% of the value of the ____ (set by the Federal Reserve). After that, FINRA requires that you must maintain account equity of at least __% of the value of the ____. This means that the amount of cash in the account must remain at least ___% of the value of the ___
50%
Stock shorted
30%
Stock shorted
130%
Shorted stock
What happens if there is a shareholder vote and two different people think they own the same 100 shares?
If there is a close vote on a merger or a proxy fight, the investor buying the shares from the short seller will get the vote. The stock lender will have to “call in” the short sale to get their shares back if they want to vote
Suppose you short sell 200 shares at $50/share, yielding $10,000. What is your profit or loss if the stock (a) declines to $25, or (b) increases to $75? Suppose the stock doesn’t pay dividends
If the stock falls to $25, you can buy ___ shares back for $____ and return them to your broker. Ignoring commissions, you have ____. If the stock rises to $75, you can buy back ___ shares for $___ and return them to your broke. Ignoring commissions, you have ___
200 shares
$5,000
$5,000 profit
200 shares
$15,000
$5,000 loss
Suppose you short 300 shares at $30 each, and deposit $4500 cash in initial margin. If the broker requires 30% maintenance margin, if the stock rises to $35, will you get a margin call?
Liability is now ___
Total cash in account __
Equity ___
Ratio ____
Margin call? If so, how much?
Liability = $35(300) = $10500
Total cash in account = 13500
Equity = 13500 - 10500 = $3000
Ratio = 3000/10500 = 28.6%
Margin call of $150 to get cash in account up to 130% of liability
For short sales of stock, FINRA industry rules require that account equity must always be maintained at $__ per share or more for stocks trading below $___ per share, at least ___% of current market value for stocks trading between $___ and $___ per share, and at least ___% of the current market value for stocks trading for more than $___ per share
$2.50
Below $2.50 per share
100%
$2.50-$5.00 per share
30%
More than $5.00 per share
Stop orders can be entered to provide some ____ for ___ sellers. A buy stop order directs the broker to buy the stock at the ___ if the __ price equal or exceeds the __ price
Loss protection
Market
Ask
Stop
Short interest is the number of a company’s ___ that have been sold ___. Short interested can be compared across stocks by calculating ____ divided by ____, or short interest divided by ___
Shares
Short
Short interest rates divided by shares outstanding
Float
Float is ____ minus ____
Total shares outstanding minus shares held by corporate insiders
Since shorting a stock is __ and __, sophisticated investors won’t do it unless they strongly believe that the stock will ___.
Costly and risky
Fall
Stocks with relatively ____ interest tend to underperform stocks with relatively ___ interest in ___ months
High short
Low short
Subsequent
Historically, stocks tend to go __, so on average, short sellers probably will ___ money. Retail investors do not earn __ on the __ of short sales. Spend your time searching for ____ stocks to buy, not searching for ___ stocks to ___
Up
Lose
Interest
Proceeds
Undervalued
Overvalued
Short sell
When you buy a stock with cash , your maximum loss is limited to your ___. When you short sell a stock, there is _____.
If the stock price keeps going up, and you continue to put more money in to your account to _____, you lose more and more money
Initial investment
No limit on potential loss
Satisfy margin calls
Insider Trading:
Legal: When corporate insiders buy and sell stock in ____. When corporate insiders trade in their own securities, they must ____.
Illegal: Buying or selling a security in ____ of a ____ or other relationship of trust and confidence, while in possession of _____. Insider trading violations may also include “___” such information, securities trading by the person “___” and securities trading by those who misappropriate such information
Legal:
Their own companies
Report their trades to the SEC within two business days
Illegal:
Breach of a Fiduciary
While in possession of material, nonpublic information about the security
“Tipping”
“Tipped”