Fundamentals Of Investments Flashcards
Best efforts
Underwriter agrees to sell as much of the offering as possible
The risk of the issue not selling resides with the firm any shares not sold are returned to the public
Firm commitment
The underwriter agrees to buy the entire issuance of stock from the company
The underwriter may buy the stock from the company and sell it higher making a spread
The risk that an issuance may not sell resides with the underwriter
Prospectus
Outlines the risks management team business operations fees and expenses
Must be issued by an investment company prior to seeking shares to an investor
Red herring
Preliminary prospectus issued before the SEC approval and is used to determine investors interest in the security
10K and 10Q
A 10k is an annual report of financial statements filed with the SEC. the 10k is audited
A 10Q is a quarterly report that is filed with the SEC. the 10Q is not audited
Annual report
Contains a message from the chairman of the board on the progress in the past year and outlook for the coming year
The annual report is sent directly to the shareholders
Liquidity
How quickly something could turn into cash with little to no price concession
Marketability
When there is a ready made market for something. Real estate is marketable, but not very liquid
Market order
The time and speed of execution are more important than price
A market order is more appropriate for stocks that are not thinly traded
Limit order
The price at which the trade is executed is more important than the timing
A limit order is more appropriate for stocks that are extremely volatile and are not frequently traded
Stop order
The price hits a certain level and turns to a market order
A stop order to sell means that once the order price is reached, the stock is sold at that price or possibly less because it has become a market order
The primary risk is that the investor may receive significantly less than anticipated if the market is moving too quickly
Stop limit or stop loss limit order
The investor sets two prices:
The first price is the stop loss price, once the price is reached the order turns into a limit order
The second price is the limit price. An investor will not sell below the second price
The risk is that if the market moves quickly the order may not fill and the investor will be left with the stock at a significantly lower price
A stop loss limit order is appropriate for investors with a significant gain built into the stock but may not want to sell the stock during a period of significant volatility based on short term news
Initial margin
The amount of equity an investor must contribute to enter a margin transaction.
Regulation T set the initial margin at 50% and was established by the federal reserve
The initial margin can be more restrictive based on the volatility of the stock
On the exam assume 50% margin requirement unless stated otherwise in the question
Maintenance margin
Minimum amount of equity required before a margin call
Margin position
Current equity position of the investor
Stock at $50 using 75% margin. Fell to $40 per share. What is new margin position?
Margin position = equity / FMV
Margin position = 27.5 / 40 = 68.75%
Equity = stock price - loan Equity = $40 - ($50 x . 25)
Margin call formula
Margin call = loan / 1 - maintenance margin
Cash dividends
Qualified dividends receive capital gains treatment
A cash dividend is taxed upon receipt
Stock dividends
Not taxable until the stock is sold
Four basic premises of traditional finance
Investors are rational - investor decisions are logical, free from emotion or irrationality, take into account all available information
Markets are efficient - at any given time, a stocks share price in the market incorporates and reflects all relevant information about that stock. Stocks are deemed at all times to trade at their fair market value on stock exchanges
The mean-variance portfolio theory governs - mean variance investors choose portfolios by evaluating mean returns and variance for their entire portfolios
Returns are determined by risk - the CAPM is the basic theory that links return and risk for all assets by combining a risk-free asset with risky assets from an efficient market
Assumptions of behavioral finance
Investors are normal - normal investors have normal wants and desires but may commit cognitive errors (through biases or otherwise) can be mislead by emotions while they are trying to achieve their wants
Markets are not efficient - there can be deviations in price from fundamental value so that there are opportunities to buy at a discount or sell at a premium
The behavior portfolio theory governs - investors segregate their money into various mental accounting layers. This mental process occurs when people compartmentalize certain goals to be accomplished in different categories based on risk rather than viewing their entire portfolio as a whole. This may result in having very different risk preferences for the same value depending on the goal or situation.
Risk alone does not determine returns - the behavioral asset pricing model determines the expected return of a stock using beta, book to market ratios, market capitalization ratios, stock “momentum”, the investors likes and dislikes about the stock company, social responsibility factors, status factors and more
