Final Exam Flashcards
Define Efficient Technical Analysis
The search for recurrent and predictable patterns in stock prices
Define Efficient Fundamental Analysis
Analysis of 1. quality of management 2. balance sheet 3. patents held 4. earnings forecast 5. accounting practices 6.dividend announcements 7.interest rates to arrive at a proper stock price
Weak Form 3
Stock prices already reflect all info found by examining the market trading data including
1. historical prices
2. trading volume
3. an short interest
(Ex. Random walk and Trading rules/ Technical analysis)
Semi Strong Form 7
all public information on the firm is reflected in the stock price including:
- past price
- fundamental analysis
Strong Form
Stock prices reflect private information and insider information
Efficient Market Hypothesis
the notion that stocks already reflect all available information (3 forms)
4 Types of Technical Analysis
- Trend Extrapolation (filter rules, resistance points)
- Serial Correlation
- Moving Averages
- Indicators (confidence index, put/call ratio)
Reason Arbitrage May Not Happen (6)
- Fundamental Risk
- Implementation Costs (restrictions on short sales/ transaction costs)
- Model Risk (bad model)
- Siamese Twin companies (fundamental risk)
- Equity Carve Outs (limited short sales)
- Closed End Funds ( rational return expectations)
Define CAPM
Provides us with a measure of an assets risk and its expected return and attempts to provide the equilibrium expected return for a risky asset
(gives benchmark rate of return to compare investments
3 Types of Anomalies of EMH
- Small Firm Effect (January)
- Book to Market Ratios (powerful predictor of returns)
- Reversals (due to overreaction)
2 Small Firm Effects (January)
- the neglected firm effect
2. the liquidity effect
Behavioral Finance says (2)
- What if investors don’t behave rationally
2. The people factor matters`
Information Processing Problems (4)
is the inability to correctly forecast due to
- Forecasting Errors
- Sampling Issues (representativeness)
- Conservatism (too slow to update belief)
- Overconfidence
Decision Making Limitations (4)
- Framing
- Mental Accounting
- Regret Avoidance
- Prospect Theory
Framing
how choices are presented
Mental Accounting
A type of framing when people segregate decisions
Prospect Theory
Rational Risk Adverse ( utility increases with wealth)
Preferred Stock
Valued as a perpetuity and uses zero growth model
Sustainable Growth Rate
maximum growth a firm can sustain without expanding financial leverage
Plowback Ratio
the fraction of earnings reinvested in firm
Plowback=1- dividend payout ratio
Common Size Analysis
restatement of financial statement information in a standardized form
Horizontal Common Size Analysis
Uses account amounts in a specific year as base year. Useful to compare growth of different accounts over time
Vertical Common Size Analysis
Uses aggregate value for a given year as base
Balance sheet: each account/ Total assets
Income Statement: Each account/ sales or revenue
DuPont Formula
uses relationships among financial statement accounts to decompose a return into components
5 parts of ROE in DoPont Formula
- tax burden
- interest burden
- margin
- turnover
- leverage
Trailing P/E
Last EPS
Leading P/E
Forecasted EPS
DDM
a formula stating that the intrinsic value of a firm is the PV of all expected further dividends
FCF
Firm level discounted cash flow
can be used for firm or the equity
Residual Income Valuation
EVA and MVA
Activity Ratios
effectiveness in putting its asset investment to use
Liquidity Ratios
Ability to meet short term and immediate obligations
Solvency Ratios
Ability to satisfy debt obligations
Profitability Ratios
Abilty to manage expenses to produce profits from sales
Ex. ROA, ROE, PM
Open-Ended Mutual Funds (90% of Funds)
5
- issues shares when investors buy
- redeems shares when investors sell
- Priced at NAV but could be higher if charged a load
- Shares outstanding change
- Buy and sell directly with firm
Closed-End Mutual Funds (10% of Firms)
5
- Shares outstanding are constant
- investors cash out by selling to new investors
- priced at premium or discount to NAV
- Traded OTC or on an Exchange
- Need to find investors will to buy or sell
Hedge Fund (3T as of 2016)
- Allow private investors to pool assets
- Limited partnership
- Initial investment between 100k - 20M
7 Risks of Hedge Funds
- Leverage
- Short Selling
- Appetite for Risk
- Lack of Transparency
- Lack of Regulation
- Short Volatility (options)
- Conflicts of interest
Exchange Traded Fund
- basket of securities traded on exchange throughout trading day
- 1/3 cost of index mutual funds
- do not always trade at NAV
- approx 1000 ETFs today in all types of assets, sectors and indices
Ex) Spider, Diamond, Cubes
ETF Advantages
- trade continuously like stocks
- can be sold short or purchased on margin
- lower costs
- tax efficient
ETF Disadvantages
- prices can depart from NAV
- ## must be purchased from broker
Net Asset Value (NAV)
used as basis for valuation of investment company shares
- for no load funds, NAV is the price at which you can buy and sell shares
NAV Formula
NAV= market value of assets- liabilities / shares outstanding
Call Option
right to BUY
excercise if market value > strike price
Put Option
right to SELL
exercise if market value < Strike price
Call option Effects that Increase Value
Increasing
- stock price
- volatility
- time
- interest rate
Call option Effects that Decrease Value
Increasing
- Exercise price
- dividend payout
Put - Call Parity
the call plus bond portfolio (left) must cost same as the stock plus put portfolio (right)
C+(X/ 1+ rf^t)= stock price + P
Protective Put
puts can be used as insurance against stock price declines
Covered Calls
- Purchase stock and write calls against it
- Call writer gives up any stock value above X in return for the initial premium
Straddle
- Buy call and put with same exercise price and maturity
- Bet on volatility. Want strong change in stock price in either direction
- Profit made when the stock price exceeds cost of both options
- Writer is betting the stock price will not change much
Spreads
- A combo of two or more calls or puts on the same stock (differing exercise price and maturity)
- A bullish spread is a way to profit from stock price increases
Collars
An option strategy that brackets the value of a portfolio between two bounds
Bid Price
- Bids are offers to buy
- In dealer markets, bid price is the price at which the dealer is willing to buy
- Investors “sell to bid”
Bid Asked Spread
is the profit for making a market in a security
Ask Price
- Asked prices represent offers to sell
- In dealer markets, asked price is price at which the dealer is willing to sell
- Investors must pay asked price to buy the security
Define Buying on Margin
is borrowing part of total purchase price of a position using a loan from a broker
margin= % or amount contributed by the investor
-Profit when the stock rises
Initial Margin
is set by the Fed and is currently 50%
Maintenance Margin
- Minimum equity that must be kept in margin account
Margin Call
If value of securities fall too much
- add money to margin account
- sell shares
Purpose of Short Sales
profit from decline in price of a stock or security
Short Sale Mechanics
- borrow stock through a dealer
- sell it and deposit proceeds and margin in an account
- Closing out the position: buy the stock and return it to the party from which it was borrowed
Securities Act of 1933 (2)
- Registration of securities for sale: disclosure
2. Prevent fraud in sale of securities
Securities Act of 1934 (4)
- Regulation of Exchanges (eventually nasdaq)
- Create Securities and Exchange Commission
- Required periodic disclosures
- Expanded anti- fraud laws (first insider trading prohibitions)
Glass Steagall 1933
Separated commercial banks from investment banks
Securities Investor Protection Act 1970
established the Securities Investor Protection Corporation (SIPC) to protect investors from losses if their brokerage firms fail
Gramm-Leach-Bliley 1999 (3)
- Repealed Glass-Steagall
- Commercial banks could now engage in investment banking activities
- travelers/citibank was first in 1998
Sarbanes Oxley Act 2003
- only applies to public firms, and dramatically increased the cost of being public
- Required more disclosure of both on and off balance sheet items
- better auditor and internal governance controls
- independence of compensation committees
- restore confidence in public firms
Dodd Frank Reform Act 2010 (6)
- mostly affected regulatory agencies as opposed to wall street
- consolidation of regulatory agencies
- more regulation for financial institutes (derivative/ hedge funds)
- Consumer Protection reforms (no more predatory lending)
- New rules and tools for dealing with crises (revision of “too big to fail” and Orderly Liquidations)
- More coordination internationally
Financial Asset Classes (6)
- Bond Market (debt, fixed income)
- Equity Market
- Derivative Market
- Commodity Markets
- Forex Markets
- Real Estate Markets (REITs)
Active Management (3)
- Identification of undervalued investments
- Market Timing
- Role of Market Effieciency
Passive Management (3)
- Indexing
- Holding an Efficient Frontier
- Intermediation Services (agglomeration, diversification)
Systemic Risk
problems in one market spill over and disrupt other
-Contagion Effect
Money Market (3) + Examples
- new issue
- issuer receives proceeds from the sale
- Short term, liquid, low risk
Ex) T-Bills, CDs, CP
Capital Markets (3) + Examples
- Existing owner sells to another party
- Issuing firm does not receive proceeds and is not directly involved
- Longer Term, Risker
Ex) Treasury Notes, Bonds, Stocks, Derivatives
Leading Indicators
Rise and fall in advance of the economy
Ex. New housing starts
Coincident Indicators
Move with the market
Ex. GDP, industrial production
Lagging Indicators
Change after market movements
Ex. Unemployment, CPI
Primary Market
new issues of securities are offered to the public
Secondary Market
Previously issued securities traded among themselves
Ex. OTC and Exchanges
