Section II.B.

Question 1

Equity Characteristics - Size (capitalization)?

Answer 1

*Value of a company
*Multiply the share price times the number of common shares outstanding

*Example:
–ABC Co. share price = $40
–# of shares outstanding = 2 million
–Market cap = $80 million (40 x 2,000,000)

Question 2

Equity Characteristics - Style (growth or value)?

Answer 2

Growth:
* High growth expectations
* High earnings expectations
* Market price higher than fundamental valuation (due to expectations)

Value:
* Identify undervalued or out
of favor stocks or assets
* Invest in stocks that trade below intrinsic value
* Market price is lower than fundamental valuation

Question 3

Domestic vs. International?

Answer 3

• valuation - developed markets typically have higher valuations (e.g., PE ratios)
• growth prospects - developing markets typically have higher growth prospects
• income - developed companies and markets often, but not always, have higher dividend payouts
• risk - developing markets typically have higher standard deviation and other risks e.g., political, economic, financial market risks.

Question 4

What are “Developed Markets”?

Answer 4

Markets that include stable political
environment, a stable currency, financial and accounting regulations, liquidity, and established financial markets with a long history.

Examples
United States, Japan, Germany, U.K.

Question 5

What are Emerging Markets?

Answer 5

Markets that exhibit the following:
some financial and accounting standards, financial market regulation, increasing liquidity in stock and bond markets, growing economies. Not known for market efficiency.

Examples
China, Russia, Brazil, India

Question 6

What are Frontier Markets?

Answer 6

Markets that include less advanced economies and financial exchanges. Also known as “pre emerging markets”.

Risks
Currency, political instability, illiquidity, lack of regulation, lack of financial and accounting standards

Examples
African nations, certain southeast Asian nations, much of Central and South America, Eastern Europe

Question 7

What are ADRs vs. Ordinary Shares?

Answer 7

Question 8

Business cycle as it pertains to equities?

Answer 8

*Expansion (recovery)
*Peak (high)
*Contraction (recession)
*Trough (low)

Resource
Key Concepts slides, Section I.B.2. Economics

Question 9

Economic indicators as they pertain to
equities?

Answer 9

*Leading
*Lagging
*Coincidental

Resource
Key Concepts slides, Section I.B.2. Economics

Question 10

What is Book Value?

Answer 10

Question 11

Intrinsic Value vs. and Market Value?

Answer 11

*The intrinsic value (IV) is the “true” value, according to a model.
*The market value (MV) is the consensus value of all market participants.

Question 12

How is Required Return calculated?

Answer 12

Question 13

P/E and Growth Rate?

Answer 13

Wall Street rule of thumb:
The growth rate is roughly equal to the P/E ratio.

“If the P/E ratio of Coca Cola is 15, you’d expect the company to be growing at about 15% per year, etc.

But if the P/E ratio is less than the growth rate, you may have found yourself a bargain.”

Quote from Peter Lynch in
One Up on Wall Street

Question 14

What are the Liquidity Ratios?

Answer 14

Not on Formula sheet

Question 15

What are the Global Indices of Equity?

Answer 15

*price weighted
*cap weighted
*fundamentally weighted
*equal weighted Resource

CIMA Textbook, Chapter 9, pp. 456
469

Question 16

What is Price-Weighted Average?

Answer 16

Question 17

What is Cap Weighted Index?

Answer 17

also known as a “market value weighted index” this index weights individual companies or stocks based on their market capitalization thus larger stocks receive more proportional representation in the index; the value of a cap weighted index may be computed by summing the value of all market capitalizations and dividing by the number of stocks in the index

Question 18

Advantages and Disadvantages of Cap-Weighted Index?

Answer 18

Advantages
*mirrors the change in the total market value of all stocks.
*Rebalancing is simple.
*easy to create a tax efficient mutual fund or ETF to track this type of index.

Disadvantages
*reflects emotions over the short term.
*heavily influenced by the few companies with the largest market capitalizations.

Question 19

What is Fundamentally Weighted Index?

Answer 19

a type of equity market index where selection and weighting criteria are based on factors such as revenue, dividends, or book value (i.e., measurements of fundamental

Question 20

Advantages and Disadvantages of Fundamentally Weighted Index?

Answer 20

Advantages
* not influenced by short term emotions/price. - pricing errors are random.

• Changes are slow, so the index can be managed through ETFs or mutual funds on a relatively tax efficient basis.

Disadvantages

does not use relative or absolute value to determine company weights.

Question 21

What is Equal Weighted Index?

Answer 21

Defined
an index in which all securities or components are given equal (the same) weighting

Question 22

Advantages and Disadvantages of Equal-Weighted Index?

Answer 22

Advantages
* highly diversified
*does not overweight overpriced stocks and underweight underpriced stocks.
*Easy to construct relatively tax efficient ETFs and mutual funds.
*Usually adds 1- 2 percent in annual return over long periods after expenses vs. market cap weighted indexes.

Disadvantages
*No distinction made between the relative or absolute valuation of stocks
*Difficult to keep the stocks in the index equally weighted due to constant price fluctuations.
* Difficult for this type of index to manage substantial amounts of money

Question 23

Potential benefits and risks of international diversification in a portfolio?

Answer 23

Benefits
- Less risky portfolio (smoother returns experience if well diversified)
- Opportunity for higher returns
- Can diversify political, economic and currency risk

Risks
- Can increase exposure to political, economic and currency risk
- Higher fees and costs
- Less transparency in some cases
May increase volatility (if not properly diversified)

Question 24

Possible reasons for increased correlations?

Answer 24

Question 25

What are the different Forms of PE?

Answer 25

*Current PE
*Forward PE
*Past PE
*CAPE

Question 26

What is P/E Ratio? Defined and Example.

Answer 26

Question 27

What is Shiller PE Ratio?

Answer 27

Question 28

Q: Bulldog Inc. has a price per share of $112 and has earnings per share of $5.12. Over the last 10 years it
has had an average earnings per share of $3.89 per share, with and EPS adjusted for inflation of $3.40 over
the same period. Calculate the Shiller CAPE ratio.

Answer 28

Question 29

What is Price-Earnings-Growth Rate (PEG Ratio)?

Answer 29

Question 30

What is Book-to-Market?

Answer 30

• book value/market value

a measure of an asset’s value calculated by dividing the asset’s book (accounting) value by its market value

• a positive ratio indicates that the market is discounting the asset

Question 31

What is Book Value?

Answer 31

Question 32

What is Price to Book Ratio?

Answer 32

Defined
Calculated by dividing the share price by book value per share. It can also be calculated by dividing the market capitalization by the book value (assets liabilities). This metric compares a
stock’s price to its accounting or book value.

Examples
P/B ratio = share price/[(assets
liabilities)/shares outstanding]

Question 33

What is Return on Equity (ROE)?

Answer 33