Equity

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informationally efficient capital market

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one in which the current price of a security fully, quickly, and rationally reflects all available information about that security

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factors that affect a market’s efficiency

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Number of market participants.

Availability of information

Impediments to trading

Transaction and information costs.

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Weak-form market efficiency

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current security prices fully reflect all currently available security market data

past price and volume (market) information(no technical analysis)

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Semi-strong form market efficiency.

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current security prices fully reflect all publicly available information.

(no fundamental analysis)

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Strong-form market efficiency

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prices ully reflect all information from both public and private sources. The strong form includes all types of information: past security market information, public, and private (inside) information

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statutory voting

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each share held is assigned one vote in the election of each member of the board of directors

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cumulative voting

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shareholders can allocate their votes to one or more candidates as they choose.

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Cumulative preference shares

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promised fixed dividends, and any dividends that are not paid must be made up before common shareholders can receive dividends.

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participating preference share

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Investors in participating preference shares receive extra dividends if firm profits exceed a predetermined level and may receive a value greater than the par value of the preferred stock if the firm is liquidated

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Convertible preference shares

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can be exchanged for common stock at a conversion ratio determined when the shares are originally issued

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private investment in public equity

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a public firm that needs capital quickly sells private equity to investors. The firm may have growth opportunities, be in distress, or have large amounts of debt. The investors can often buy the stock at a sizeable discount to its market price.

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Direct investing

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Direct investing in the securities of foreign companies simply refers to buying a foreign firm’s securities in foreign market

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Depository receipts (DRs

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ownership in a foreign firm and are traded in the markets of other countries in local market currencies

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sponsored DR;

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Company selling its stock is involved with the issue of DR

A sponsored DR provides the investor voting rights and is usually subject to greater disclosure requirements. In an unsponsored DR, the depository bank retains the voting rights.

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American depository receipts

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denominated in U.S. dollars and trade in the United States

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Global registered shares

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traded in different currencies on stock exchanges around the world.

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Non-Cyclical firm

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Defensive industries- least affected by the stage of the business cycle and include utilities, consumer staples

Growth industries- have demand so strong they are largely unaffected by the stage of the business cycle

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Economic profits

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The return on invested capital minus its cost. The degree of economic profits depends in part on pricing power (elasticity of demand for the firm’s products)

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strategic analysis

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examines how an industry’s competitive environment influences a firm’s strategy

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Michael Porter's 5 forces

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Rivalry among existing competitors

Threat of entry

Threat of substitutes

Power of buyers

Power of suppliers

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Industry Capacity effect on prices

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Undercapacity, a situation in which demand exceeds supply at current prices, results in pricing power and higher return on capital. Overcapacity, with supply greater than demand at current prices, will result in downward pressure on price

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embryonic stage

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slow growth, high prices, large investment, high failure rates

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grwoth stage

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rapid growth, limited compeittion, falling prices and rising profitability due to economies of scale

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shakeout stage

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slowed growth, intense competition, higher capacity, lower proitabilit, cost cutting,

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mature stage

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slow growth, consolidation, high barriers to entry, stable pricing, best firms gain mkt share

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decline stage

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Negative growt,Declining prices, Consolidation

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Porter 2 strategies

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cost leadership (low-cost) strategy or a product or service differentiation strategy.

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enterprise value

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Enterprise value is the market value of all a firm’s outstanding securities minus cash and short-term investments

EV = market value of common and preferred stock + market value of debt – cash and short-term investments

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asset-based models

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the intrinsic value of common stock is estimated as total asset value minus liabilities and preferred stock

Analysts typically adjust the book values of the firm’s assets and liabilities to their fair values when estimating the market value of its equity

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dividend discount model(DDM)

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current value of stock = sum of all dividends discounted back to PV

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One-year holding period DDM

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the value of the stock today is the present value of any dividends during the year plus the present value of the expected price of the stock at the end of the year (referred to as its terminal value).

value = div / (1+k) + year end px / (1+k)
where k = required rate of return

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4 types of eq valueation models

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DCF

mkt multiplier - P/E

mkt multiplier - EV/ EBITDA

Asset Based

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Free cash flow to equity

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often used in discounted cash flow models instead of dividends because it represents the potential amount of cash that could be paid out to common shareholders.

FCFE = net income + depreciation – increase in working capital – fixed capital investment (FCInv) – debt principal repayments + new debt issues

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Simple FCFE equation

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FCFE = cash flow from operations – FCInv + net borrowing

net borrowing = increase in debt during the period (i.e., amount borrowed minus amount repaid)

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CAPM

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Req return = Rf + beta(exp return mkt - Rf)

provides an estimate of the required rate of return (ki) for security

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Preferred stock Div Discount

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Dividend / Required return

(just a simple terminal growth)

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Gordon Growth Model (constant growth model)

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assumes the annual growth rate of dividends, gc, is constant.

Value = D0 (1+g) / (req return - g)

if given D1 then do NOT multiply numerator by 1+g

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sustainable growth rate

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sustainable growth = (1 – dividend payout ratio) × ROE

sustainable growth = retention rate × ROE

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retention rate

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(1 – dividend payout ratio)

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Gordon growth, no current dividend

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Ex: Nothing from now till year 4. year 4 is $2, k=10% g=5%

2/(.10-.5) =40 is your year 3 value

40 / (1+.1)^3 = 30.07

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multistage dividend discount model.

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Discount cashflows back of dividends at growth rate a using (1-k)^n

Find terminal value at a future date with growth b Dn+1 / (k-b)

discount that TV to today using (1-k)^n

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P/E based on fundamentals or justified P/E

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Expected Dvd Payout ratio / (k-g)

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law of one price

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which asserts that two identical assets should sell at the same price, or in this case, two comparable assets should have approximately the same multiple.

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three main functions of the financial system

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Allow entities to save and borrow money, raise equity capital, manage risks, trade assets currently or in the future, and trade based on their estimates of asset values

Determine the returns (i.e., interest rates) that equate the total supply of savings with the total demand for borrowing.

Allocate capital to its most efficient uses.

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Money market vs capital market

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Capital markets refer to markets for longer-term debt securities and equity securities that have no specific maturity date.. MM is less than 1 yr

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Traditional investment markets

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refer to those for debt and equity.

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Pooled investment vehicles

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Mutual Funds, HFs ,ETFs, ABS

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real assets

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real estate, equipment, and machinery etc

provides income, tax advantages, and diversification benefits

usually require the investor to do substantial due diligence before investing.

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Brokers

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help their clients buy and sell securities by finding counterparties to trades in a cost efficient manner

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Exchanges

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provide a venue where traders can meet. Exchanges sometimes act as brokers by providing electronic order matching.

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Alternative trading systems

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which serve the same trading function as exchanges but have no regulatory function, are also known as electronic communication networks (ECNs) or multilateral trading facilities (MTFs). ATS that do not reveal current client orders are known as dark pools.

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Dealers

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facilitate trading by buying for or selling from their own inventory. Dealers provide liquidity in the market and profit primarily from the spread (difference) between the price at which they will buy (bid price) and the price at which they will sell (ask price) the security or other asset

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primary dealers.

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Dealers that trade with central banks when the banks buy or sell government securities in order to affect the money supply

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depository institution

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include banks, credit unions, and savings and loans. They pay interest on customer deposits and provide transaction services such as checking accounts.

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Insurance companies

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they collect insurance premiums in return for providing risk reduction to the insured. The insurance firm can do this efficiently because it provides protection to a diversified pool of policyholders, whose risks of loss are typically uncorrelated

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Moral hazard

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occurs because the insured may take more risks once he is protected against losse

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Adverse selection

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when those most likely to experience losses are the predominant buyers of insurance

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Clearinghouses

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Act as intermediaries between buyers and sellers in financial markets and provide: Escrow services (transferring cash and assets to the respective parties). Guarantees of contract completion. Assurance that margin traders have adequate capital.

LIMIT counterparty risk,

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Custodians

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also improve market integrity by holding client securities and preventing their loss due to fraud or other events that affect the broker or investment manager.

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payments-in-lieu: short sellers

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In a short sale, the short seller must pay all dividends or interest that the lender would have received from the security that has been loaned to the short seller.

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short rebate rate

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The short seller must also deposit the proceeds of the short sale as collateral to guarantee the eventual repurchase of the security. The broker then earns interest on these funds and may return a portion of this interest to the short seller at a rate

If the security is difficult to borrow, the short rebate rate may be lower or negative.

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call money rate,

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The interest rate paid on the funds

for margin

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leverage ratio

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$ borrowed/ $of your own used

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Return in % w/ leverage

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Profit (end price +dividends - start price) - (Call $ rate * borrowed $) - Commission
/ $ invested

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maintenance margin requirement

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To ensure that the loan is covered by the value of the asset, an investor must maintain a minimum equity percentage

Margin call price = Initial px *((1- IM) / 1- Maintence margin)

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call markets,

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tock is only traded at specific times.

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quote-driven markets,

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traders transact with dealers (market makers) who post bid and ask prices. Dealers maintain an inventory of securities

dealer markets, price-driven markets, or over-the-counter markets

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order-driven markets

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order precedence hierarchy. Price priority is one criteria, where the trades given highest priority are those at the highest bid (buy) and lowest ask (sell). If orders are at the same prices, a secondary precedence rule gives priority to non-hidden orders and earliest arriving orders

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brokered markets

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brokers find the counterparty in order to execute a trade