FINAL EXAM MC Flashcards
Efficient Market
- Information is widely and cheaply available to all investors
- Security prices are reflecting all relevant and ascertainable information
Efficient Market Hypothesis
Prices react quickly and unambiguously to new information.
Weak Form Efficiency
Security prices reflect all information found in past prices and volume
Semi-Strong Form
Security prices reflect all publicly available information
Strong Form
Security prices reflect all information, public and private.
Why does technical analysis fail?
Investor behaviour tends to eliminate any profit opportunity associated with stock price patterns.
Technical Analysis
Trading rules based on patterns of price and volume.
Fundamental Analysis
Research the value of stocks using NPV and other cash flow measurements.
Post-Earnings Announcement Drift:
Investors underreact to the earnings announcements.
The New-Issue Puzzle
On average the investors who receive new issues receive an immediate capital gains, but those gains often turn into losses.
Temporal Anomalies: January Effect
Stock prices generally soar in January.
4 Factors of Behavioural Finance
- Overconfidence
- Representativeness
- Conservatism
- Anchoring
Behavioural Biases
- Mental Accounting
- Regret Avoidance
What type of betas do highly cyclical stocks have?
Higher Betas
Operating Leverage
- Refers to the sensitivity of a firm relative to its fixed production costs
- Increases as fixed costs rise and variable costs fall
- Magnifies cyclical effects on beta
Financial Leverage
Refers to the sensitivity of a firm relative to its debt level
When do you use the industry beta?
When the firm’s operations are similar to those of other firms in the industry.
When do you use the firm’s beta?
When the firm’s operations are fundamentally different from other firms in the industry.
Stock Splits
Increase share liquidity and reduce adverse selection costs and increases the number of small and uninformed traders holding the stock
What does beta measure?
- Security’s contribution to the market portfolio’s total risk
- Security’s responsiveness to changes int he market portfolio
- Security’s market risk or systematic risk
Capital Market Line
- Traces the efficient set of holding formed with bot risky assets and the risk-free asset
- Measures risk using standard deviation
Security Market Line
- Relates return to market risk (beta) not to total risk (standard deviation)
- All properly priced individual securities and portfolios should lie on the SML
Concerns of CAPM
- Practical problems with estimating required returns
- CAPM is not testable
Diversification
Substantially reduces the variability of returns without an equivalent reduction in expected returns.
Systematic (Market) Risk
-Economy-wide random events that affect almost all assets to some degree
Unsystematic (diversifiable) Risk
-Random events that affect single security or small groups of securities
Limitations with P/E Ratio
- Uninformative when companies have negative or very low, earnings
- One year’s earnings can fall but a stock price is a function of many years
- Earnings volatility creates great volatility in P/E Ratios
When does a firm experience earnings growth?
When net investment is positive.
Concerns of Dividend Discount Model
Hard to Estimate:
-future dividends, growth rates, discount rates
What if firm’s don’t pay dividends
Model only works if r > g
