Fundamentals of Investments (Lesson 1) Flashcards
What is the best efforts from of underwriting
- Underwriter agrees to sell as much of the offering as possible
- Risk of not selling resides with the firm because any shares not sold are returned
What is the firm commitment for underwriting
- underwriter agrees to buy the entire issuance of the stock from the company
- the risk of a stock now selling resides with the underwriter
What does the prospectus do
- outlines the risks, management team, business operations, fees and expenses
- must be issued by an investment company prior to selling shares to an investor
What is a red herring document
- Preliminary prospectus issued before the SEC approval and is used to determine investors interest in the security
What is a 10K
- is an annual report of financial statements filed with the SEC
- 10K is audited
What is a 10Q
- is a quarterly report that is filed with the SEC
- 10Q is not audited
What is an annual report
- contains a message from the Chairman of the board on the progress in the past year and outlook for the coming year
- sent directly to shareholders
What is liquidity
- how quickly something can be turned into cash with little to no price concession
- Stocks, bonds, stock mutual funds, and stock bond funds are not considered liquid
What is marketability
- exists when there is a ready made market for something
- real estate is marketable but not very liquid
What is a market order
- timing and speed of execution are more important than price
- most appropriate for stocks that are not thinly traded
What is a Limit order
- The price at which the trade is executed is more important than the timing
- Limit order is most appropriate for stocks that are extremely volatile and are not frequently traded
What is a stop order
- price hits a certain level and turns to a market order
- a stop order to sell means that once the stop order price is reached the stock is sold at the price or possibly less because it becomes a market order
What is a Stop limit or stop loss limit order
- the investor sets two prices
- first price is the stop loss price once this price is met the order turns to a limit order
- second price is the limit price. investor will not sell below this price
- Risk is that the market is moving quickly the order may not be filled and the investor will be left with the stock at a significantly lower price
When is a stop limit or stop loss limit order appropriate
- for investors with a significant gain built into the stock but may want to sell the stock during a period of significant volatility
What is short selling
- Investor makes a profit if the price decreases in value
- Investor must have a margin account to protect against any price appreciation of the stock
What happens to the dividends during a short sell
- they must be covered by the short seller
What is an initial margin
- reflects the amount of equity an investor must contribute to enter a margin transaction
What did regulation T set the initial margin requirement at
- 50% and was established by the federal reserve
What is the maintenance margin
- the minimum amount of equity required before a margin call
What is the margin position
- represents the current equity position of the investor
What is the formula for margin position
MP = Equity / FMV
Equity = Stock price - Loan
What is the formula for Margin call
MC = Loan / (1 - Maintenance Margin)
Where must an investor restore their equity to in a position
- to the maintenance margin
What does value line rank and how does it rank them
- Stocks on a scale of 1 to 5 for timeliness and safety
- 1 is highest rank (buy signal)
What does Morningstar rank and how does it rank them
- Mutual funds, stocks, and bonds using 1 to 5 stars
- 1 star is lowest rating
Who declares dividends paid
- by board of directors and paid quarterly
What is the ex dividend date
- Date the stock trades without the dividend
- If sell on the ex dividend date then you will receive the dividend
- if you buy on the ex dividend date then you will NOT receive the dividend
When is the ex dividend date
- one day before the date of record
What is the date of record
- the date on which you must be a registered shareholder in order to receive the dividend
When is the date of record
- one business day after the ex dividend date
Does an investor that purchases the stock two business days prior to the date of record receive a dividend
- Yes
Will an investor receive a dividend if it is purchased on the ex dividend date
- No
When is a stock dividend taxed
- Not taxable until the stock is sold
What did the Securities Act of 1933 do
- Regulates the issuance of new securities
- Requires new issues are accompanied with a prospectus before being purchased
What did the Securities Act of 1934 do
- regulates the secondary market and trading of securities
- Created the SEC to enforce compliance with security regulations and laws
What did the Investment Company Act of 1940 do
- Authorized the SEC to regulate investment companies
- three types of investment companies: Open, Closed, Unit Investment Trusts
What did the Investment Advisor Act of 1940 do
- Required investment advisors to register with the SEC or state
What did the Securities Investors Protection Act of 1970 do
- Established the SIPC to protect investors for losses resulting from brokerage firm failures
- Does not protect against bad investments
- Protects accounts member firms open for clients regardless of the clients citizenship
What did the insider trading and securities fraud enforcement act of 1988 do
- Defines an insider as anyone with information that is not available to the public
- Insiders cannot trade on that information
What are treasury bills
- Issued in varying maturities up to 52 weeks
- denominations in $100 increments through Treasury direct up to $5 million per auction
What are commercial paper
- Short term loans between corporations
- Maturities of 270 days or less and it does not have to register with SEC
- Denominations of $100,000 and are sold at a discount
What is bankers acceptance
- Facilitates imports/exports
- Maturities of 9 months or less
- Can be held until maturity or traded
What are Eurodollars
- deposits in foreign banks that are denominated in US dollars
What does a IPS establish
- Client objectives
- Limitations on investment manager
Does the IPS include investment selections
No
What does the IPS establish
- RR TTLLU
- Risk
- Return
- Taxes
- Time line
- Liquidity
- Legal
- Unique Circumstances
What is a critical step in developing the IPS
- Assessing the clients rick tolerance
What is the Dow Jones Industrial Average
- Simple price weighted average
- DJIA does not incorporate market capitalization
What is the S&P 500
- Value weighted index
- incorporates market capitalization of individual stocks into the average
What is the Russell 2000
- Value weighted index
- smallest market capitalization stocks in the Russell 3000
What is the Wilshire 5000
- value weighted index
- broadest of index
- measures the performance of over 3,000 stocks
What is the EAFE
- value weighted index
- tracks stocks in Europe, Australia, Asia, and the Far East
What are the four basic premises of Behavioral finance
- Investors are Rational
- Markets are efficient
- Mean variance Portfolio theory governs
- Returns are determined by risk (CAPM)
(Behavioral Finance Assumption)
What does the assumption investors are normal mean
- Normal investors have wants and desires but may commit cognitive errors through biases or otherwise
- Normal investors may be misled by emotions while they are trying to achieve their wants
(Behavioral Finance Assumption)
What does Markets are not efficient mean
- There can be deviations in price from fundamental value so that there are opportunities to buy at a discount or sell at a premium
- Markets are tough to beat but are not efficient
(Behavioral Finance Assumption)
What does Behavioral Portfolio Theory Governs
- Investors are segregate their memory into various mental accounting layers
- occurs when people compartmentalize certain goals to be accomplished in different categories based on risk rather than using the entire portfolio as a whole
(Behavioral Finance Assumption)
What does risk alone does not determine returns
- the behavioral asset pricing model determines the expected return of a stock using:
- Beta
- Book to market cap ratios
- momentum
- investor likes or dislikes about the stock or company
- social responsibility factors
What is the difference between a rational investor and a normal one
- Normal investors are prone to making cognitive mistakes due to their beliefs or cognitive biases
What is affect heuristic
- deals with judging something whether it is good or bad
- Like or dislike based on non financial issues
What is anchoring
- Attaching or anchoring ones thoughts to a reference point even though there may be no logical relevance or is not pertinent to the issue in question
- also known as conservatism or belief perseverance
What is availability heuristic
- decision maker relies upon knowledge that is a readily available in his or her memory
- Overweight recent events or patterns while paying little attention to longer term trends
What is bound rationality
- rational is limited by available information
- Seeks a satisfactory solution rather than a optimal one
- Cannot consider significant information
What is confirmation bias
- people tend to filter information and focus on information supporting their opinions
What is cognitive dissonance
- tendency to misinterpret information that is contrary to an existing opinion or only pay attention to information that supports existing opinion
What is disposition effect
- regret avoidance or fault framing
- normal investors do not mark their stocks to market prices
What is familiarity bias
- investors tend to overestimate/underestimate the risk of investments with which they are unfamiliar/familiar
What is gamblers fallacy
- investors often have incorrect understanding of probabilities which can lead to faulty predictions
What is herding
- People tend to follow the masses or the herd
What is hindsight bias
- looking back after the fact is known and assuming they can predict the future as readily as they can explain the past
What is illusion of control bias
- tendency for people to overestimate their ability to control events
What is overconfidence bias
- listens mostly to himself or herself, overconfident investors mostly rely on their skills and capabilities to do their own homework or make their own decisions
What is overrcation
- common emotion towards the receipt of news or information
What is prospect theory
- people values gains and losses differently and will base their decisions on perceived gains rather then perceived losses
- Investors are loss adverse and have an asymmetric attitude to gains and losses
What is recency
- giving to much weight to recent observations or stimuli
- focusing on short term past performance
What is similarity heuristic
- decision or judgment is made when an apparently similar situation occurs even though the situations may have very different outcomes
What is naïve diversification
- Investing in every option available to the investor
- Common in 401k or employer sponsored plans
What is representativeness
- thinking that a good company is a good investment without regard to an analysis of the investment
What is familiarity
- causes investment in companies that are familiar such as the employer
What is loss aversion
- investors avoid losing more than experiencing gains
- Feel more pain from losses
