Cfa Level 1 Stocks

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characteristics of well-functioning securities market

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1.Timely and accurate information
2.Liquidity
3.Internal efficiency
4.Informational(external)efficiency

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What is primary capital markets?

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it refers to the sale of new issues of securities.Most issues are distributed with the aid of an underwriter.

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underwriter services to the issuer in primary market.

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1.Origination-design, planning, and registration of the issue.
2.Risk bearing- the underwriter insures or guarantees the price by purchasing the securities.
3.Distribution, the sale of the issue.

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Definition: negotiated sale

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price of underwriting are negotiated b/w firms and investment banks.

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Definition: competitive bid

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price of security is decided through auction. This is the most case in municipal bonds.

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Definition:private placement

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the method whose security is sold by investment banker to a small number of buyers or a single buyer. The issue is not registered with the SEC for public sale.

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Definition: Best efforts underwriting.

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it indicates that the investment banker does not take the price risk. That is, underwriter sells issue for the best available price with no price guarantees to the firm.

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Definition:call market.

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the market in which stock is only traded at specific times.it is used in smaller markets and to set the opening price in major markets.

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Definition: continuous market.

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The market in which trades occur at any time the market is open.The price is set by either the auction process or by dealer bid-ask quotes.

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What is NASDAQ short for?

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National Association of securities dealers automated quotation.

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Definition: over-the-counter market.

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market that include the trading in all securities not listed on one of the registered exchanges.

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Definition: Third market.

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the segment of OTC market that trades registered exchange.

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Definition: Fourth market.

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direct exchange b/w investors.

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is auction market a price-driven or dealer market?

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price-driven

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is OTC market a price-driven or dealer market?

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dealer

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basic functions provided by specialists:

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1.act as brokers handling the limit order book, where limit and stop orders are maintained
2.act as dealers by buying and selling stocks for their own accounts to maintain an orderly market and provide liquidity to the market if there is an inadequate order flow.

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processes of short selling

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1.simultaneously borrows and sells securities through a broker
2.must return the securities at the request of the lender or when the short sale is closed out
3.must keep a portion of the proceeds of the short sale on deposit with the broker.

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3 rules for short selling:

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1.uptick rule:stocks can only be shorted in an up market.
2.The short seller must pay all dividends due to the lender of the security
3.the short seller must deposit collateral to guarantee the eventual repurchase of the security.

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The lending rate of margin compare with the bank call money rate

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1.5 percentage above the call money rate

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margin requirement for margin current

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50%, which means borrower must provide 50% of the funds in the trade.

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Definition: maintenance margin of a investment account

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investor's required equity position in the account.it is applicable to both margin purchase and short sales.

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What amount is the maintenance margin in us?

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25%

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equation:Trigger price for margin purchases

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TP = p0(1-initial margin)/(1-maintenance margin)

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equation: trigger price for short selling

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p0(1+initial margin)/(1+maintenance margin)

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In the us who sets the initial margin account requirement?

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The federal reserve board

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Definition: seasoned issues

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issues of new share of firms whose shares are already trading in the market.

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if a stock priced at 40, the order that buys the stock at 45 is called:

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limit order

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equation: new margin account balance WRT initial margin balance and change in stock value

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new margin account balance = initial account balance - change in stock price

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equation: price-weighted index

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PWI = sum of stock prices / # of stocks in index adjusted for splits

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what are the two major price-weighted indexes

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Dow Jones Industrial Average(DJIA) and the Nikkei Dow Jones Stock Average.

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How many stocks in DJIA

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30

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Which stock will influence a price-weighted index better? a high-price stock or a low-price stock?

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high

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what is the major problem of a value-weighted index

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firms with greater proportion of market will have greater impact.

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what is the assumption of purchasing unweighted index

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it assume you invest an equal dollar in each stock in the index.

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what is the assumption of purchasing price-weighted index

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it assume you invest equal number of shares in each stock in the index.

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what is the assumption of purchasing market value-weighted index

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it assumes you invest equal market value in each stock in the index.

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how are the downward bias on the index are created?

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By large firms spiting their stock to lower the weight due to lower price.

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Semi-Strong Form Efficiency

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A class of EMH (Efficient Market Hypothesis) that implies all public information is calculated into a stock's current share price. Meaning that neither fundamental nor technical analysis can be used to achieve superior gains.

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Weak Form Efficiency

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One of the different degrees of efficient market hypothesis (EMH) that claims all past prices of a stock are reflected in today's stock price. Therefore, technical analysis cannot be used to predict and beat a market.

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In what form of efficiency according to EMH can a fundamental hypothesis achieve abnomal profit?why?

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weak-form. it assume that price are accurately reflected by market info. in other words, some info outside the market, which could be obtained by fundamental analysis, is useful.

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Strong Form Efficiency

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The strongest version of market efficiency. It states all information in a market, whether public or private, is accounted for in a stock price. Not even insider information could give an investor the advantage.

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the main task of portfolio managers

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1.minimize transaction costs
2.help clients try to outperform the market
3.diversify the portfolio to minimize risk

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equation: abnormal return(risk adjusted)

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AR = actual return-(market return + beta(market return - risk-free return))

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Definition:efficient capital market

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one in which the current price of a security fully reflects all the information currently available about that security, including risk.

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limitations on market's ability to produce informationally efficient prices.

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1.time delay.If price adjusts due to new info in hours, it is efficient; if it take days, it is not
2.transaction cost make price higher than the efficient price
3.There are limits on the ability of the process of arbitrage to bring about efficient prices.

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steps in top-down approach

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1.economic
2.sectors(industry)
3.stock

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assumptions of the infinite period DDM:

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1.the dividends grow at constant rate
2.growth rate, gc, is contant
3.ke, the cost fo capital must exceed gc.

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equation: infinite period DDM

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valu = D0(1+g)/(k-g)=D1/(k-g)

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stages of the business cycle

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1.recovery
2.early expansion
3.late expansion
4.slowing, entering recession
5.recession

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what is the return expectation depends on:

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1.demand
2.the value chain

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identify the stage of an industry's life cycle

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1.Pioneering phase: limited growth, low or negative profit.
2.Rapid accelerating growth phase: demand growth rapidly, high sales and profit due to low level of competitions.
3.mature growth phase: sales growth above normal but stops accelerating. profit is diminishing due to competition.
4.stabilization and market maturity phase:growth approach es average, profit reduces by competition, ROE becomes normal.
5.Deceleration of growth and decline.

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definition: concentration ratio

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percentage market share of the N largest firms in an industry.

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definition: Herfihndahl index

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a measure of concentration of a industry, which is represented by the sum of the squared market share of the N largest firms(N-firm Herfindahl index) or all the firms(Herfindahl index for the entire industry)

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5 factors that determine industry competition

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1.Rivalry among the existing competitors.
2.Threat of new entrants.
3.Threat of substitute products.
4.Bargaining power of buyers
5.Bargaining power of suppliers.

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Attractive investments in recovery phase

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cyclicals, commodities and commodity-linked equities

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Attractive investments in early expansion phase

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stocks and real estate

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Attractive investments in Late expansion phase

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bonds and interest-sensitive stocks.

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Attractive investments in slowing, entering recession phase

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bonds and interest-sensitive stocks

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Attractive investments in recession phase

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commodities and stocks.

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Definition: Trilling P/E

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Market price per share / EPS over last 12 months

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leading P/E

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market price per share / forecast EPS over next 12 monthes

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Rationales of P/E

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1.EPS is the primary determinant of investment value
2.popularity
3.studies shows the EPS is highly correlated to long-run stock performance.

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drawbacks of P/E

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1.it is useless when EPS is negative.
2.some volatile, transitory portion of earning make interpretation of P/E difficult
3.Management discretion within allowed accounting practices can distort reported earnings and thereby lessen the comparability of P/E ratios across firms

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advantages of P/BV

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1.Book value is cumulative, thus usually positive. It can be used even EPS is negative.
2.BV is more stable than EPS
3.BV is an appropriate measure of net asset value for firms that primarily hold liquid assets, lisk finance, investment, insurance, and banking firms.
4.P/BV can be useful for bankrupting firms.
5.research shows that P/BV help explain differences in long-run average returns.

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Disadvantages of P/BV value

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1.P/BV do not recognize human capital and other nonphysical assets.
2.it is misleading when there are significant differences in the asset intensity of production methods among firms under consideration.
3.Different accounting convention like R&D cost can obscure the true value of firms across countries.
4.Inflation and tech change can cause book and market value different alot.

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Equation: P/BV

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P/BV = market value of equity/Book value of equity = Market value per share/ Book value per share

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equation: Book value of equity

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total asset - total liability - preferred stock

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The BV in P/BV is the book value of

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equity