Week 9 Flashcards
What tends to occur to a firm’s PE ratio as it ages?
Young firms tend to be fast growing and hence have a high PE ratio, though this may be lowered by their risk. Mature firms tend to be slow growing and hence have a low price to earnings ratio, though this may be boosted by the firm’s low risk.
Why is a high price to earnings stock more risky?
It floats on a cushion of very high forecast of growth in earnings, despite high price to earnings ratios not being typically reported as a good forecast of growth in earnings per share.
What is required for there to be Present value of growth opportunities?
Earnings retention and existence of future positive net present value investments to be above 0(meaning the return on equity must be higher than the return rate required by CAPM.
What does technical analysis involve what are some common modern techniques?
Technical analysis uses past prices and returns to forecast future stock returns, modern techniques include things like short-term reversal, medium-term price momentum, and long-term reversal.
What are direct and indirect transaction costs?
Direct transaction costs are stated before the transaction. Indirect transaction costs are variable and estimatable, but not known with 100% accuracy in advance.
Why are market order submitters naive liquidity takers? What can be a better option?
They will always hit the least attractive price when they come across a bid-ask spread. A better option can be to use a limit order, as in these cases the broker must conduct the price at the limit price or better.
What is a designated market maker? Why are they important? What ETFs in NZ use them?
Someone appointed by the stock exchange to act as a market maker. They must post bids and asks and some minimum depth. This is done to create a fair and orderly market, supplying liquidity so price does not move too quickly. They essentially act like runescape flippers, selling at the ask price and buying at the bid by setting limit orders.
NZX sponsored ETFs use designated market makers.
What is the cost of using a limit order (supplying liquidity)? What is the advantage?
If the market prices are moving the transaction prices may move away from your limit price, maeaning we will not get an execution. However if the markets are stable, trading using a limit order can allow us to sell our stock half a spread above fair value instead of half below.
What might be a case where there are no market orders or limit orders?
Mutual funds, as we buy direct from the supplier.
What is the difference between deflating a monetary value and discounting it?
In deflating we use the inflation rate to calculate present value. In discounting we use our required rate of return.
What is price impact?
As our stock order is filled we eat up liquidity, increasing price, or decreasing if we are selling.
What is price improvement?
Price improvement occurs when both the seller and purchaser of a stock receive a better price than they expected.
What are some of the precedences for limit orders?
Price priority: A limit order with a superior limit to other limit orders pushes the limit to the top of the book.
Time priority: When limits are equal the first one in is executed against incoming orders first.
There is also quantity priority in some cases.
Is liquidity a transaction cost?
The liquidity cost of a market order is often considered a transaction cost.
What is a
“bid-ask bounce”?
The price of a stock often bounces between the bid and the ask, this is known as the “bid-ask bounce”. This occurs as a result of equilibrium, if fair value is the middle of the spread, the next transaction is roughly equally likely to be at the bid or the ask, causing the price to jump between both.
When a trade goes off at the ask that is almost certainly a customer buying, at bid a customer selling.
