Flashcards
Primary Market - L1
business/gov raise capital
ownership/equity via selling stock
borrow $ by issuing debt (bonds)
Secondary Market - L1
subsequent sale & purchase of securities
allows/provides liquidity
Going Public Advantages (3) - L1
raising capital (cash)
creating currency & liquidity by creating stock
creating awareness & credibility
Going Public Disadvantages (3) - L1
exposure - high SEC registration costs
stock prices & shareholder value create pressure to increase stock price
loss of control via selling ownership
Underwriting - L1
help issuing firm determine its financial needs & how to best raise needed funds
Best Efforts - L1
investment bank sells securities to investors; any unsold shares returned to issuer
Firm Commitment - L1
investment bank purchases all securities from firm & sells securities to public; most common
Market Participants (4) - L1
Individual Advisors
SROs
Securities Exchanges
Broker Dealers
OTC - L1
trade unlisted securities over the counter
Broker Dealers - L1
individuals/firms that buy/sell securities either for clients or for themselves; FINRA & SEC registration required
3rd Market - L1
exchange listed securities traded OTC
4th Market - L1
huge blocks b/t institutional investors via electronic communications network ECN
Markowitz - L1
market efficiency based on risk only
Sharpe - L1
systematic & diversifiable unsystematic risk - Capital Asset Pricing Model - Beta (B)
Modern Portfolio Theory MPT - L1
risk averse investors are rational & make decisions that maximize their well being
Efficient Market Hypothesis (5) - L1
- Financial markets informationally efficient (prices reflect relevant info)
- Investors form rational expectations regarding future price movements
- Security prices follow random walk (price changes = random/unpredictable)
- Changes in relevant info will instantaneously be reflected in price changes
- Price changes are virtually impossible to predict
3 Levels of Informational Efficiency - L1
Weak Form Market Efficiency
Semi Strong Efficiency
Strong Form Efficiency
Weak Form Market Efficiency - L1
technical analysis = useless
beat w/ fundamental analysis & insider trading
asset prices reflect hx pricing & volume information
Semi Strong Efficiency - L1
technical/fundamental analysis = useless; only beat w insider trading
asset prices reflect all publicly available info; investors cannot use publicly available info to generate an excess return
Strong Form Efficiency - L1
everything = useless; not even beat by insider trading
asset prices reflect all relevant info, including private information
SEC - L1
Regulatory oversight = transparency, integrity, accuracy in financial reporting & decision making
GOAL = protect investors, maintain fair orderly & efficient markets & facilitate capital formation
Investment Advisors Act 1940 (ABC Rule) - L1
supports investor protection
any person/firm engaged in business of providing advice to others or issuing reports or analyzes regarding securities
ABC Rule:
Advice, Business, Compensation
SROs - L1
FINRA
private non governmental organizations w/ limited authority to enforce ethical & fair standards among businesses operating in the financial services industry
promote trust, protect investors, improve efficiency
Cash & Money Market Securities (3) - L1
liquid/marketable
ST maturities 12 months or less
low risk/volatility
Fixed-Income Securities (3) - L1
bonds = form of debt
diversify portfolio
provide income stream to investor
Equity Securities (3) - L1
common stock = ownership
more risk
potential more return
Asset Classes (3) - L1
Cash & Money Market Securities
Fixed Income Securities
Equity Securities
Skewness - L2
measures lack of symmetry in bell curve;
skewed left has negative skewness
Skew Right - L2
high peak far left side; long tail decreasing in level on right side
mode > median > mean
Ex. TBills positively skewed right since returns cannot be negative
Kurtosis - L2
measures thickness of the tails of a distribution (height of tails)
Leptokurtic - L2
increased/positive kurtosis = data peaked at mean, more observations in tails
equities returns tend to be leptokurtic d/t increased volatility
Platykurtic - L2
low/negative kurtosis
Risk Tolerance is a function of….(6) - L3
- loss/risk aversion
- available liquidity, savings & insurance programs
- time horizon
- goals
- investor’s place in life cycle
- psychology
Diversification - L3
including a # of different investments in a portfolio to reduce the portfolio’s unsystematic risk
better achieved by combining two assets that are not perfectly correlated (r<1)
Perfect Hedge - L3
two assets r = -1 combined; provides expected return no higher than risk free rate
Coefficient of Determination - L3
= R^2
tells us how much the variability of one asset can be explained w/ variability in the other
calculated by squaring the correlation coefficient
R^2 = 100% = perfectly mirrors
R^2 = 0% = totally independent of market
The Efficient Frontier - L3
identifies efficient frontier from all possible combinations of assets
diversification helps minimize portfolio risk
incorporating both E[r] and risk into the analysis assists in decision making
Indifference Curve = representation line consisting of portfolios an investor would be willing to hold based on tradeoff of risk/return
Optimal Portfolio - L3
point at which investor’s highest indifference curve is tangent to the efficient frontier
MPT - L3
addition of a risk free ROR to the efficient frontier framework creates the capital market line
Capital Asset Pricing Model (CAPM) - L3
theoretical & difficult to apply in practical setting
a) MPT combines CMline w/ efficient frontier strategy; incorporates beta
b) combination of risk free asset, market return, & beta form security market line (SML), model = CAPM
CAPM = a portfolio’s expected ROR is based on the risk free rate plus a premium based on the portfolio systematic risk
Asset Allocation Decision - L3
portfolio weights assigned to to reflect investor’s risk profile weights: (4)
expected returns
volatility
market expectations
measure of risk tolerance
two common approaches: strategic asset allocation and tactical asset allocation
Strategic Asset Allocation - L3
think NYSE
developing appropriate diversification strategy across broad set of asset classes
minimize probability significant losses that would impact overall portfolio
Factors (4):
LT expected return on equities
fixed income & real assets
LT goals
risk tolerance
Tactical Asset Allocation - L3
think crypto
outperform market over shorter periods of time by investing in asset classes the investor expects will outperform market returns over the period
requires active management
market timing, anticipate future market movements
less effective in more efficient markets
Discounted Cash Flow Technique & Intrinsic Value - L4
fundamental analysis; firm’s value = ability generate cash for investors
IV = PV expected cash flows
IV > P(market); security is undervalued
IV < P(market); security is overvalued
Relative Valuation w/ Multipliers - L4
fundamental analysis; valuing a company by comparing it to value of its competition
Benefits: requires far fewer assumptions, simpler to understand, more realistic estimations
Challenges: many many firms to choose from, should be based on historical evidence of improved portfolio performance
Relative Measures: PE ratio, Price to book ratio (PB), price to sales ratio (PS), price to cash flow (PCF), enterprise to earnings
Technical Analysis - L4
use of historical pricing & volume data to make asset selection decisions
multiple ineficienciencies
uses S&D conditions to locate trends in asset prices
T.A. relies on market not being completely efficient
two common patterns: resistance levels & support levels
Indexing - L4
select financial instruments track collection of investment securities w/ no effort spent on individual security evaluation
no benefit in paying more for active management; assumes efficient market w/ fair price
lower expense ratios then active strategies
capture asset classes, NOT security selection
Benchmark Portfolio - L4
evaluating portfolio performance w/ out comparing that performance to similarly constructed portfolios ignores the systematic risk influence that affect all portfolios
popular indexes used for benchmarks: S&P500, Wilshire 5000 Index
more complex way is to select securities w/ high correlations w/ securities in portfolio
= customized portfolio containing securities in universe the manager typically holds, weighted as the manager would typically weight portfolio
Active Portfolio Management - L4
skilled fund managers, broad mix, +- based on performance
requires WEAK form market efficiency
research suggests advisors cannot consistently identify high performing funds
Passive Portfolio Management - L4
index ETFs or mutual funds, whichever more tax efficient
use passive ETFs that may capture opportunities to earn returns w/ positive historical Jensen’s Alpha
Examples: value, small size, momentum, low volatility (also known as research based investing)
Core and Satellite Portfolio Management - L4
allocate majority of wealth to low cost index ETFs or MFs to capture beta
other portion to capture other benefits: active alpha risk hedging (inflation protection) unique diversification opportunities satisfy client's desire to hold an allocation of individual firms or sectors
Buy & Hold Strategy Portfolio Rebalancing Techniques - L4
investor does nothing to rebalance portfolio weights
lower transaction costs
investors comfortable w/ allowing rising/falling markets to change their original allocations
over time, allocation could be drastically different = creates significantly different return and risk profiles than @ inception
Constant Weighting Allocation Portfolio Rebalancing Techniques - L4
investors initially decide on strategic allocation
target weights fluctuate in narrow range
Fixed Income Securities F.I.S. - L5
debt instrument, issuer promises to pay interest on face value of instrument for period of time, then repay face value @ maturity, wide variety of issuers
Money Market Deposit Accounts MMDAs FIS - L5
allow investors earn interest on funds not currently invested in stocks & other investments
invest in MM securities indirectly
ST var rate, issued by banks & MF companies
Coupon Rate - L5
annual rate of interest paid on face value (par value) of the bond
higher cpn rate, more interest paid; often paid semiannually
Corporate Bonds - L5
subject fed & state taxation
corporations sell bonds to finance operations
rated to reflect default risk associated w/ a bond
ratings affect overall yield
Secured Bonds - L5
bonds backed by collateral
most bonds are unsecured (debentures)
Zero Coupon Bond - L5
no regular interest pmts
purchased @ discount
matures @ face value
Call Provision - L5
allows issuer to call bond prior to maturity
Puttable Bond - L5
allows bond owner to sell (put) bond back to issuer at a predetermined price and time
advantageous when interest increases