Midterm Review Flashcards
Market Order
An order to buy or sell stock at the best price available. It is the quickest way to fill orders because they are usually executed as soon as they reach the exchange floor. Because of the speed, an investor can be reasonably sure the price at which the order is transacted will be very close to the market price of the prevailing market.
Limit Order
An order to buy at or below a specified price, or to sell above a certain price.
Stop Order
Broker tells the market maker to sell a stock when its market price reaches or drops below a certain specified level.
Stop Limit Order
Sets a limit on the price an investor will receive. May not be filled if the price moves quickly.
Initial Margin
Amount of equity an investor must contribute to enter a margin transaction. Example: To purchase 100 shares of Starbucks trading at 50$ per share with an initial margin requirement of 75%, Joe must contribute 100x 50 x .75= 3750 and he will borrow 1250 from his broker.
Maintenance Margin
The minimum amount of equity required before a margin call.
How do you figure out the price at which investor receives a margin call?
Loan/1-Maintenance Margin
Example: Joe Purchased 100 shares of Starbucks trading at 50 per share with a maintenance margin requirement of 75 and a maintenance margin of 35. At what price would Joe receive a margin call. Answer 19.23
How do you calculate how much an investor must contribute in a margin call?
Actual Equity- Required Equity.
Primary Market
The market in which new issues are sold to the public. Includes the initial public offering, rights offering, and private placement.
Secondary Market
The purpose of the secondary market is to provide investors with a method to buy and sell securities issued in primary markets. Provides continuous pricing of securities and provides liquidity to shareholders. Includes NYSE, NASDAQ, OTC and AMEX
What are some ways investors can invest internationally
Indirectly- US Multinational Companies
Directly: Buying stock of a company on foreign exchanges, buying stock of company on us exchanges, american depository receipts, Yankee bonds.
What are some of the most important financial regulations in the US over the past century?
Securities Act of 1933- Regulates the issuance of new securities. Securities act of 1934- Regulates the secondary market and trading securities; created the sec as the regulator of the securities exchanges. Investment Company Act of 1940- Authorized SEC to regulate investment companies. Three Types- Open, Closed, Unit Investment Trusts. Investment Adviser Act of 1940- Investment advisers must register with SEC. Securities Investors Protection Act of 1970- Protects investors for losses resulting from broker firm failures, does not protect investors for incompetence or bad investment decisions.
Price-weighted
Dow Jones Industrial Average. Does not incorporate market capitalization
Value weighted index
Incorporates market capitalization of individual stocks into the average.
Holding Period Return
(Selling Price- Purchase Price +/- Cash Flows)/ Purchase Price. Not a compounded rate of return. There is no consideration for the time an investment was held. HPR questions will come from margin return or after tax rate returns
What are the three factors that must be taken into account when calculating weighted average portfolio return?
- Current market value of the securities held. 2. Total portfolio value. 3. The return of each security.
Coefficient of Variation
Useful when comparing two assets with different average returns. The higher the coefficient of variation, the more risky an investment and the less likely an investor is to achieve the average return. Standard Deviation/ Average Return
Covariance
The co-variance is the measure of two securities combined and their interactive risk. Measure of relative risk. Co variance= Standard deviation a times standard deviation b.
Correlation/Correlation Coefficient
Correlation and the co-variance measure movement of once security relative to that of another. Covariance is a relative measure. Correlation coefficiant is a relative measure.
(COVAB)/ (Standard deviationA*Standard DeviationB)
Co-relation Coefficient ranges.
Ranges from +1 to -1
+1 Denotes two assets are perfectly correlated
0 Denotes that the assets are completely uncorrelated
-1 Denotes perfectly negative correlation
Diversification begins with anything bellow +1
Beta
Beta is a measure of systematic risk or market risk, whereas standard deviation is a measure of total risk. Beta is the slop of the regression line (asset returns regressed against benchmark returns) Beta is an appropriate measure of risk for a well diversified portfolio.
Beta Coefficient
A measure of an individuals security’s volatility relative to that of the market. The beta of the market is 1. Anything above 1 fluctuates more than the market and has greater risk. A stock with less than 1 indicates that the security fluctuates less than the market.
R Squared
Also called coefficient of determination. Measures how much return is due to the market. If the correlation coefficient is .80 then its r squared is 64 percent. Which means 64 percent is due to the market. R squared tells us if beta is an appropriate measure of risk.
Systematic risk
The lowest risk one would expect a fully diversified portfolio to have. It is inherent in the system.
Unsystematic risk
Is the risk that exists in a specific firm or investment that can be eliminated through diversification.
Systematic risks are…
PRIME (Purchasing power risk, reinvestment rate risk, interest rate risk, market risk, exchange rate risk)
Unsystematic risks are
ABCDEFG (Accounting risk, business risk, country risk, default risk, executive risk, financial risk, government/regulation risk)
Modern Portfolio Theory
is the acceptance by an investor of a given level of risk while maximizing their expected return objectives.
The efficiency frontier
Curve which illustrates the best possible returns that could be expected from all possible portfolios
Investors are risk averse
They require compensation for taking on additional risk
Indifference curves
Constructed by using selections made based on the highest levels of return given an acceptable level of risk
Efficient portfolio
Occurs when this goal is accomplished
Optimal portfolio
Is the one selected from all efficient portfolios.
Capital asset pricing model
Calculates the relationship of risk and return of an individual security using beta (b) as its measure for risk
What is ratio analysis?
Ratio analysis is the study of the relationships between financial statements accounts and it provides a historical perspective. Must infer future performance based on historical perspective. Understanding key ratios allow investor to better understand the connection between elements of financial performance.
SWOT Analysis
Strength, weaknesses, opportunities and threats. Conduct ratio analysis.
Financial statements
Balance sheet, income statement, statement of cash flows. The financial statements are the most important source of information. Focus on trends, not just the last couple of years worth of results. How reliably can the trends be projected into the future? The purpose is to determine intrinsic value.
Profitability ratios
Net profit margin= net profit after taxes/ total revenues. Essentially a rate of return on sales
Return on assets
Net return after taxes/ total assets. The higher the better.
Return on equity
Net profit after taxes/ total equity. The higher the better!
PEG Ratio
Stock PE ratio/ 305 year growth rate in earnings. What is driving the PE ratio, stock price or earnings growth? If less than or equal to 1, the growth is due to earnings. If greater than 1, the PE is outpacing earnings growth.
Dividends per share=
annual dividend/ # of common shares outstanding
Payout Ratio
Dividends per Share/ Earnings per Share
Stock Valuation
The process by which the underlying value of a stock is established on the basis of its foretasted risk and return performance.
Value of a stock is a function of its future returns
*Earnings per share *EPS multiple *Dividends
Dividend discount model
Values a company’s stock by discounting the future stream of cash flows. (Stocks next annual dividend)/(Required return-Dividend growth rate)
Dividend Yield
Dividends per share/ stock price
Random Walk Theory
The behavior of stock closely resembles a random walk. Stock prices are unpredictable but not arbitrary. There is a reason why prices behave that they do, but forecasters cannot predict with consistence or accuracy what the response to any given stimuli will be. Prices are in equilibrium
Efficient Market Hypothesis
Weak- Historical information will not help investors achieve above average market returns. Esseintally rejects technical analysis. Semi Strong- historical and public information will not help investors achieve above average returns. Rejects technical and fundamental analysis. Strong- historical, public and private information will not help investors achieve above average returns. Rejects technical & fundamental analysis, and also inside information. So, diversify stocks randomly or morely go with an index.
Technical Analysis
Including forecasting future stock prices based upon. Charting stock market movements. Looking for formations or patterns to buy or sell. Looking at supply and demand of a stock. Approximately 20 to 50 percent of the price behavior of a stock can be traced to overall market forces.
Overconfidence
Investors underestimate the risk associated with an investment
Biased Self Atribution
Attribute success to their efforts, investment failure on others
Loss aversion
Investor dislike losses more than gains. Will hang on to losing stocks hoping they will bounce back.
Narrow Framing
Investors tend to analyze a situation in isolation, while ignoring the larger context.
Belief Perserverance
Investors tend to ignore information that conflicts with their existing beliefs.
Recency Effect
What has just happens will continue to happen.
