Investments Lesson 1 Flashcards by Lindsay Adams

Best Efforts:

Underwriter agrees to sell as much as possible

Risk resides with the firm

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Firm Commitment:

Underwriter buys entire issuance

Risk resides with inderwriter

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Prospectus:

Outlines: risks, management, business operations, fees, expenses
Must be issued prior to selling shares

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Red Herring:

Preliminary prospectus
Before SEC approval
Determines interest

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10K vs 10Q vs Annual Report:

10K: annual report of financial statements filed with SEC; audited
10Q: quarterly report filed with SEC; not audited
Annual Report: message from chairman on progress in past year & outlook in coming year; sent directly to shareholders

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Liquidity vs Marketability:

Liquidity: how quickly turned into cash
Marketability: ready-made market for something

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Market Order:

Timing & Speed more important than price

Appropriate for stocks not thinly traded

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Limit Order:

Price more important than timing

For extremely volatile & not frequently traded

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Stop Order:

Price hits certain level & turns into market order

Primary risk: investor May receive significantly less if market moving too quickly

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Stop-Limit or Stop-Loss Limit Order:

Sets 2 prices: stop loss & limit
Risk if market moves to quickly order may not fill & left with stock at a significantly lower price
Appropriate with significant gain in stock but May not want to sell during significant volatility based on short-term news

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Short Selling:

Sell at high price with hopes to buy at lower price
Profit when asset’s price decreases in value
Must have margin account
No time limit
Dividends paid by corporation must be covered by short seller

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Initial Margin:

Amount of equity investor must contribute

Assume 50% set by Fed unless otherwise stated

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Maintenance Margin:

Minimum amount of equity required before a margin call

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Margin Position:

Current equity position

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Margin Call Formula:

Loan / (1-maintenance margin)

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Investor must restore their equity position to __?

Maintenance margin

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Example Exam Question:
Purchased 500 shares XYZ trading at $40/share. Initial margin requirement of 60%. Maintenance margin of 30%. What price receive margin call?

A. $20
B. $22.86
C. $57.14
D. $80

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Example Exam Question:
Purchased 1,000 shares CWC for $80/share. Initial margin requirement of 65%.
Maintenance margin of 40%. If stock price falls to $30/share, how much equity must be contributed?

A. $2/share
B. $8/share
C. $10/share
D. $12/share

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Value Line Research Report:

1-5 ranking for stocks

1: highest for timeliness & safety (buy)
5: lowest (sell)

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Morningstar Research Report:

1-5 star ranking for mutual funds/stocks/bonds

1: lowest
5: highest

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Example Exam Question:
MSFT declared dividend payable on record date of Wednesday, May 15. What is last possible date investor could purchase & still receive dividend?

A. May 13
B. May 12
C. May 11
D. May 10

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Qualified dividends receive __?

Capital gains treatment

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Stock dividends are not taxable to shareholder until __?

Stock is sold

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Stock splits:

Increase shares outstanding

Reduce stock prices

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Example Exam Question: If June 4 is date of record, when must purchase stock to receive dividend? ``` A. June 1 B. June 2 C. June 3 D. June 4 E. May 31 ```

Securities Act of 1933:

Regulates issuance of new securities (primary market) | Requires new issues have prospectus

Securities Act of 1934:

Regulates secondary market & trading | Created SEC to enforce

Investment Company Act of 1940:

Authorized SEC to regulate investment companies | 3 company types: open, closed, unit investment trusts

Investment Advisers Act of 1940:

Requires advisors to register with SEC or state

Securities Investors Protection Act of 1970:

Established SIPC to protect investors resulting from brokerage firm failures (regardless of citizenship)

Insider Trading & Securities Fraud Act of 1988:

Insiders cannot trade on non-public information

Treasury Bills:

Maturities up to 52 weeks | Denominations in $100 incriminating up to $5M per auction - larger available through competitive bid

Commercial Paper:

Short term loans between corporations Maturities of 270 days or less; do not have to register with SEC Denominations of $100,000 & sold at discount

Banker’s Acceptance:

Facilitates imports/exports Maturities of 9 months or less Can be held until maturity or traded

Eurodollars:

Deposits in foreign banks that are denominated in US dollars

Investment Policy Statement establishes __?

``` RRTTLLU Risk Return Taxes Time-horizon Liquidity Legal Unique circumstances ```

Dow Jones Industrial Average:

Simple, price-weighted average | Does not include market capitalization

S&P 500

Value weighted index | Incorporates market capitalization of individual stocks

Russell 2000

Value weighted index of smallest market capitalization stocks in Russell 3000

Wilshire 5000

Broadest index; measures 3,000 stocks | Value-weighted

EAFE

Value weighted index | Stocks in Europe, Australia/Asia, & Far East

Traditional Finance:

Investors are rational Markets are efficient Mean-variance portfolio theory governs Returns determined by risk

Behavioral Finance:

Investors are normal Markets are not efficient Behavioral portfolio theory governs Risk alone does not determine returns

Affect Heuristic:

Judging something based on non/financial issues

Anchoring:

Reference point that may not be logical | Also called conservatism or belief perseverance

Availability heuristic:

Relies on knowledge readily available in memory

Bounded rationality:

Rationality limited by available information/tractability of decision problem/cognitive limitations of minds/time available Seeking a satisfactory solution rather than an optimal one

Confirmation bias

Focus on information supporting your opinions

Cognitive dissonance

Tendency to misinterpret information that is contrary to existing opinion

Disposition effect

Regret avoidance or faulty framing | Mark value even after price has changed

Familiarity bias

Overestimate/underestimate risk of investments they are familiar/unfamiliar with

Gambler’s fallacy

Incorrect understanding of probabilities

Herding

Follow the masses

Hindsight bias

Looking back after a fact ks know & assuming future can be predicted as readily as past explained

Illusion of control bias

Overestimate ability to control events

Overconfidence bias

Listens to self, rely on own skills & capabilities, overstate risk tolerance

Overreaction

Emotion toward receipt of news/information

Prospect theory

People value gains & losses differently Will base decisions on perceived gains rather than perceived losses Loss averse Over insured against risk

Recency

Too much weight to recent observations or stimuli

Similarity heuristic

Decision or judgement made when apparently similar situation occurs even though situations may have very different outcomes

Example Exam Question: James states investment philosophy is as a contrarian: buys securities losing favor & sells gaining favor. Review track record - equal with market. Investments are typically in a security that has lost 10% from most recent high. What type of bias is James exhibiting? A. Anchoring B. Herding C. Overconfidence D. Hindsight bias

Naive diversification:

Investing in every available option

Representativeness

Thinking good company is good investment without analysis of investment

Familiarity

Investment in companies that are familiar

Example Exam Question: Kevin subscribed to investment magazines & data resources, reads & analyzes. Utilizes this analysis to make shifts in high beta portfolio on daily basis. Which behavior finance bias is Kevin subject to? A. Hindsight bias B. Overconfidence C. Regret avoidance D. Herd mentality

Loss aversion

Prefer avoiding losses more than experiencing gains

Socialization

Process of acquiring values, beliefs? Behaviors acceptable or expected by society

Multicultural pshychology

Extension of general psychology that recognizes multiple aspects of identity influence a person’s worldview

Social consciousness

Awareness & sense of responsibility for problems/injustices within society

Lesson 1 Review: Which would you use to ascertain chairman’s perspective for progress completed & expected for the coming year? A. 10k report B. Annual report C. 10q report D. Quarterly report

Lesson 1 Review: Own 1000 shares of stock. Purchased for $25/share on margin with 50% initial margin requirement & 25% maintenance margin requirement. Price dropped to $13/share. Will there be a margin call? If so, how much? A. $1500 B. $2750 C. $3250 D. No margin call required

Lesson 1 Review: How do stock split & stock dividend impact shareholders without bringing about any changes in value of company on balance sheet? A. Value of stock split & value of stock dividend are generally small enough that impact on balance sheet is minimal B. Value of stock split & value of stock dividend increase the number of shares but not the total value of those shares C. Value of stock split & value of stock dividend cause dilution which keeps the value of the stock up without increasing the overall value on the balance sheet D. Value of stock split & value of stock dividend offset one another thereby eliminating any change that might occur to the balance sheet

Lesson 1 Review: Which would serve as analytical tool to provide information to client regarding small cap growth stocks? A. Wilshire 5000 B. S&P 500 C. Russell 2000 D. Dow Jones Small Cap Average

Lesson 1 Review: Which broad market index would be more appropriate when conducting comparisons between large cap, blue chip, & securities market? A. S&P 500 B. DJIA C. Russell 5000 D. Value Line 300

Lesson 1 Review: Buys for $50 using initial margin of 75% & maintenance margin of 40%. What price will receive margin call? A. $13.12 B. $20.83 C. $25.25 D. $66.67

Lesson 1 Review: Which is true regarding Securities Investors Protection Act of 1970? A. Protects investors from losses arising from bad investment decisions B. Requires prospectus to accompany all new issues C. Protects investors from negligence on part of investment advisor D. Act protects investors from losses arising from brokerage firm failures

Lesson 1 Review: Which is not a value-weighted index? A. DJIA B. S&P 500 C. Russell 2000 D. Wilshire 5000

Lesson 1 Review: Tells about amazing portfolio performance experiencing double digit returns in a matter of days. Lost on a few but not much. Impressed decide to invest some money with him. What behavior finance bias does he portray? A. Overconfidence B. Anchoring C. Cognitive dissonance D. Belief perseverance

Lesson 1 Review: Old Wall Street is saying “cut your losses & let your profits run”. However investors often do the opposite. Seems people are reluctant to admit they made a mistake in purchasing a stock that subsequently performs poorly. Behavior most consistent with: A. Anchoring B. Herd mentality C. Regret avoidance D. Representativeness