Topic 4 - Fundamental analysis

Question 1

Fundamental analysis seeks to identify

Answer 1

the fundamental economic and political factors that determine a security’s price.
It is basically an analysis of the (current and future) demand for and supply of a security to determine if
* a price change is imminent, and
* in which direction and by how much prices are expected to change

Question 2

Valuation of fixed-income securities
Goals:

Answer 2

• Understand how the price of bonds change when interest rates change
• Understand the different effect of interest rate changes on the price of bonds depending on the term to maturity

Question 3

What is a zero-coupon bond

Answer 3

a bond which will be reimbursed with only one single payment at maturity, including cumulated interest and principal

Question 4

Relationship between price and YTM

Answer 4

1. Inverse relationship between price and YTM
2. Longer term to maturity results in a higher change in price when the YTM changes
3. For a given bond, an increase in the YTM will result in a price decrease lower than the price increase that would result from the same decrease in the YTM

Question 5

Valuation of shares. Goals:

Answer 5

• understand the process to assess the value of shares
• understand the different methods applied, depending on the characteristics of the share

Question 6

Valuation of shares - approaches

Answer 6

1. Top-down approach
2. Bottom-up approach

Question 7

Top-down approach

Answer 7

• relies heavily on the analysis and forecasting of trends in the economy and industry
• evaluates the expected impact of changes in the world economy on the macro economy of the country
• evaluates the expected influence of these changes on the domestic industry
• identifies the stocks which are expected to outperform the market

Question 8

Bottom-up approach

Answer 8

1. places greater emphasis on individual stock selection
2. picks up stock which are undervalued and have the potential to outperform
3. despite its weakness, this approach is very popular primarily because of their inability
   - to forecats long-term economic and market trends
   - to undertake low-cost stock selection, as well as
   - their inherent tendency to speculate

Question 9

the top-down approach consists of three types of analysis

Answer 9

1. economy analysis
2. industry analysis
3. company analysis

Question 10

economy analysis

Answer 10

• growth rate of national income
• inflation and interest rates
• government deficit
• foreign trade, balance of payments and exchange rate

Question 11

industry analysis

Answer 11

• industry life cycle
• industry characteristics
• regulation

Question 12

company analysis

Answer 12

1. traditional fundamental analysis begins with the financial statement analysis to evaluate the financial solvency and profitability of the firm
2. the investor also looks at:
   * the firm’s product lines
   * the economic outlook for the products
   * the industries in which the company operates

Question 13

Concept and use of the Price Earnings Ratio

Answer 13

• how much is the market paying per unit of earnings
• number of years it would take the shareholder to recover the money invested in the share
• a high PER value shows that the market is discounting a high future growth in earnings

Question 14

Valuation of companies

Answer 14

• based on the growth prospects of earnings, the fundamental analysis attempts to determine the fair value or intrinsic value

Methods
* accounting-based
* return or cash-flow based
* multiples

Question 15

Accounting-based methods

Answer 15

1. book value
2. adjusted book value
3. liquidation value