II. INVESTMENTS -- B. Equity

Question 1

1. Equity characteristics:

Size (capitalization)

Answer 1

Microcap: up to $300m

Small-cap $300m $2b

Mid-cap $2b - $10b

Large-cap over $10b - $200b

Mega-cap over $200b

Question 2

1. Equity characteristics: Style:

Growth Investing

Answer 2

Think P/E constant, but earnings will grow so price will rise accordingly.

Aggressive.

Question 3

1. Equity characteristics: Style:

Value Investing

Answer 3

Looking for low P/E - think price too low, buy and wait for market to realize correct price.

Slow and steady.

Question 4

1. Equity characteristics: Volatility:

Defensive

Answer 4

Lower beta

Lower volatility

In industries less affected by business cycles, e.g., consumer staples and growth industries

Defensive adjustments are made to portfolios in advance of expected volatility to protect against downside volatility.

Question 5

1. Equity characteristics: Volatility:

Dynamic

Answer 5

Higher beta

Higher volatility

Higher operating leverage

In cyclical industries such as consumer discretionary, energy, financial services, industrial and producer durables, etc.

Change portfolio strategy as market volatility changes.

Question 6

1. Equity characteristics: Capital structure:

Common stock

Answer 6

Usually with voting rights

Higher risk

Fractional ownership in the company

Question 7

1. Equity characteristics: Capital structure:

Callable common stock

Answer 7

Allows firm to buy the shares back at pre-determined price

Question 8

1. Equity characteristics: Capital structure:

Putable common stock

Answer 8

Allows shareholder to sell the shares back at a pre-determined price

Question 9

1. Equity characteristics: Capital structure:

Preferred stock

Answer 9

Usually non voting

Dividends expressed as % of par value

Often cumulative

Less risk since paid first

Question 10

1. Equity characteristics: Capital structure:

Convertible preferred stock

Answer 10

Can be exchanged for C/S at a pre-determined conversion ratio

Conversion option more valuable when C/S price increases

Often used to finance risky ventures as conversion feature compensates investors for the additional risk they take when investing in such firms

Question 11

2. Equity valuation methods: Security analysis:

Dividend discount

Answer 11

Price = Present value of expected future dividends

Question 12

2. Equity valuation methods: Security analysis:

Free cash flow

Answer 12

EBIT * (1-t) + Depreciation - Change in NWC - CAPEX

Question 13

2. Equity valuation methods: Security analysis:

Weighted average cost of capital

Answer 13

WACC = R_d*(1-t)*(D/V) + R_e*(E/V)

Question 14

2. Equity valuation methods: Economic analysis:

Business cycle as it applies to equities

Answer 14

Noncyclical stocks are less affected by the business cycle, and will have lower risk premiums and higher valuations than cyclical stocks. Cyclical stocks are characterized by high business risk and operating leverage.

Question 15

2. Equity valuation methods:

Industry and sector analysis

Answer 15

By sector, strategy, etc.

Could use Porter’s 5 forces.

Question 16

2. Equity valuation methods:

Fundamental analysis

Answer 16

Financial statement and other analysis

Question 17

2. Equity valuation methods: Fundamental analysis:

Statement of financial position

Answer 17

Assets = Liabilities + Shareholders’ Equity

Question 18

2. Equity valuation methods: Fundamental analysis:
   Statement of operations

Answer 18

Revenue - Expenses + Gains - Losses

Question 19

2. Equity valuation methods: Fundamental analysis:

Statement of cash flows

Answer 19

CFO + CFI + CFF

Question 20

2. Equity valuation methods: Common financial ratios:

Price-Earnings

Answer 20

Price per share/Earnings per share

Question 21

2. Equity valuation methods: Common financial ratios:

Price-Book

Answer 21

Price per share/Book value per share

Question 22

2. Equity valuation methods: Common financial ratios:

Price-Sales

Answer 22

Price per share/Sales per share

Question 23

2. Equity valuation methods: Common financial ratios:

Return on Equity

Answer 23

ROE = Net income/Average Equity

ROE = Profit Margin * Total Asset Turnover * Leverage
Profit Margin = Net income/Sales
Total Asset Turnover = Sales/Average Assets
Leverage = Average Assets/Average Equity