Week 1 Flashcards
Investment (definition)
The process of committing funds to one or more asset that will be held over some future periods with the expectation of wealth generation
Expected return (definition)
The anticipated return expected by investors over some future holding period
Realised return (definition)
The actual return on an investment over some previous period
Risk (definition)
The chance that the realised return on an investment will differ from the expected return
Risk tolerence (definition)
The extent of risk that an investor is willing to undertake
Risk-return tradeoff (definition)
The principle that the higher the risk the higher the reward
Risk and return have what type of relationship?
Positive
What is an example of a risk free security?
Government bonds
Direct investment (definition)
Where investors buy and sell securities themselves, typically through brokerage accounts
Indirect investment (definition)
Where investors buy and sell shares of investment companies which, in turn, hold portfolio of securitites
Example of a non-marketable financial asset
Savings account
Example of a marketable financial asset
Stocks and bonds
Money market security (definition)
Securities with an original maturity of 1 year or less. Highly-liquid and considered very safe. Issued by governments or private firms
Capital market securitites
Securities with more than 1 year in original maturity
What are the four types of bonds
- corporate bonds-issued by companys for debt financing
- municipal bonds
- government bonds
- agency bonds
Why might a company issue bonds rather than get a bank loan?
Bond market offers more favourable terms and has lower interest rates
Preferred stock (definition)
Shares of a company with dividends that are paid out before common stock dividends are issued. The dividend is fixed. Typically do not hold voting rights
Common stock (definition)
Equity security representing ownership. ‘Residual claimants’ on income and assets and have no promise from the company to recieve dividends. Typically have voting rights
Book value (definition)
The accoutning value of the equity as shown on the balance sheet
Aggregate market value (definiton and how to calculate)
Measures the total value of all outstanding equity shares. Calculated by multiplying price per share with the cumber of shares
Dividend yield (definition and how to calculate)
The percentage of a compnays share price that it pays out in dividends. Calculated by divinding the dividend per shar with the stock price
Payout ratio (definition and how to calculate)
Percentage of net income a firm pays to its stock holders. Dividing dividends with net income
P/E ratio (definiton)
Ratio of stock price to historical or estimated earnings. Basically shows how much the market pays for $1 of earnings
Stock dividend (definition)
A payment by the corporation in shares of stock rather than cash
Stock split (definition)
A corporate action that divides each share into multiple shares
Why do companys split stock?
- preffered trading range for stock is between $10-$100. Less attractive to investors if outside that range
- conveys positive information about the firms performance. Unsuccesful companys wouldn’t split stock
- generates publicity
What is a derivative?
Instruments whos value is derived based on prices of other assets
Options (definition)
Financial derivative that gives the buyer the right to buy and sell the underlying asset at a stated prices within a specififed period
Futures (definiton)
Financial derivative that obligate the parties to transact an asset at a predetermined future date and price
Forwards (definition)
A financial derivavtive that is an agreement between two parties to undertake an exchange at an agreed future date at a price agreed now
Swaps (definition)
A derivative contract in which one party exchanges one stream of cash flow for another from another party
Hedgers-what they use derivatives for example
Wheat farmer and buyer. Agree to a fixed price to buy wheat as the price fluctuates.
Goal to reduce potential loss
Speculators
Speculators trade based on their educated guesses on where they believe the market is headed. For example, if a speculator thinks that a stock is overpriced, they may sell short the stock and wait for the price to decline, at which point it can be bought back for a profit.
Primary market
Market for new issues of securities, typically through investment bankers. Raising captial for firms
Secondary market
Buying and selling exisiting assets. Such as LSE and NYSE
