Week 6: Stock Market

Question 1

What is the difference between OTC markets and organized exchanges? Give one example for each

Answer 1

Organized Exchange: implies specific location. E.g. NYSE
OTC: thinly-traded securities, dealers ready to make market. E.g. NASDAQ

Question 2

What are the 2 types of systems for stock exchange?

Answer 2

Order-driven: more transparent
Quote-driven: more liquid

Question 3

What are the Electronic communication networks? What are their advantages?

Answer 3

Systems that allow brokers & traders to trade without a middleman
Advantages:
1. Transparency: everyone sees orders
2. Cost reduction: smaller spreads
3. Faster execution
4. After-hours trading

Question 3

What are the drawbacks of ECNs?

Electronic Communication Systems

Answer 3

1. Major exchanges trying to fight against them
2. Many ECNs, competing for volume
3. Don’t work well with thinly traded stocks

Question 4

What is the formula for the one-period valuation method?

Answer 4

Price = Div/(1+r) + Price/(1+r)

r = discount rate or risk

Question 5

What is the formula for the generalized divident valuation model?

Answer 5

Price = Sum of [div/(1+r)^t]

div = divident at period t

Question 6

What is the formula for the Gordon Growth Model?

Answer 6

Price = div/(r-g)

g = dividend growth

Question 7

What is the formula for the Price-Earnings valuation method?

Answer 7

Price = P/E * E

P/E = price/earnings ratio
E = earnings per share

Question 8

What are some errors that can occur with the Gordon growth model?

Answer 8

Pricing can be affected by:
1. Growth Estimation
2. Risk estimation
3. divident forecasting

Question 9

Margin formula:

Answer 9

Margin = equity/value of securities

Question 10

What is the difference between price and performance indices?

Answer 10

Price indices do not reinvest dividends

Question 11

What are Exchange Traded Funds?

Answer 11

Basket of securities, traded on major exchanges

Question 12

What is the advantage of ETFs?

Answer 12

• Diversification
• Low transaction costs
• Less time spent on stock picking

Question 13

Why purchase foreign stocks?

Answer 13

diversification

Question 14

What are the 4 SEC divisions, what is each one responsible for?

Answer 14

Corporate Finance: collect, review, publish docments
Regulation: Establish & Maintain rules
Investment Management: oversees and regulates investment management industry
Enforcement: Investigates violations

Question 14

What are the 4 SEC divisions, what is each one responsible for?

Answer 14

Corporate Finance: collect, review, publish docments
Regulation: Establish & Maintain rules
Investment Management: oversees and regulates investment management industry
Enforcement: Investigates violations

Question 15

What are dual class share, why are they criticized?

Answer 15

Shares with more ownership than regular shares.
They’re criticized because they allow insiders to retain control for decades

Question 15

What is the problem with relying on Analysts?

Answer 15

They are often too optimistic

Question 16

What are important factors to consider when saving money?

Answer 16

• Stock pricing vs Diversification
• Time horizon
• Liquidity concern
• Save regularly