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66 Cards in this Set
- Front
- Back
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preferred shares |
-no voting rights=passive ownership -fixed dividends usually paid out -senior claim over common shares -usually <10% of company shares -come after bonds on the pecking order of firm obligations |
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common shares |
-voting rights -don't necessarily get dividends -residual claimant=paid after all of the firm's other obligations have been met (after current liability, long-term debt, preferred equity) |
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In the US, are interest payments are tax-deductible? |
Usually, yes. This includes coupon payments and mortgage interest. This is why corporations have an incentive to choose bonds over preferred shares. |
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MB of buying shares |
receiving future dividend stream
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MC of buying shares |
market price
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shares authorized |
shares that shareholders and the board authorize the firm to sell to the public=maximum potential supply |
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shares issued |
shares that have been issued or sold to the public |
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shares outstanding |
shares that are currently held by the public |
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Order shares issued, outstanding, and authorized by greatest to least |
Shares authorized > shares issued > shares outstanding |
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additional paid-in capital |
the money the firm received from selling stock, above and beyond the stock's par value |
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Why is the FCF approach to valuation helpful? |
You don't need dividends to figure it out. Recall that FCF=what's left after the firm meets all operating needs and pays for investments, both in the long-term and short-term |
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FCF approach to valuation |
1) estimate FCF generated over time 2) Discount FCF @ firm's WACC to derive firm's total value=Vf 3) Subtract values of firm's debt and preferred stock to obtain value of firm's shares. Vs=Vf - Vd - Vp 4) Divide Vs by number of shares to obtain price per share. |
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relationship between standard deviation and risk |
-lower returns=lower risk=lower SD=lower variance |
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Does the risk-return tradeoff apply to individual stocks or asset classes or both?
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-not to individual stocks, but to asset classes |
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MB of investing |
risk-return tradeoff |
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MC of investing |
risk |
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Calculate g
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g=ROE x retention rate ROE=net income/owner's equity retention rate =net income - dividends / net income |
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book value |
value of firm's equity as recorded on balance sheet |
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liquidation value |
amount of remaining cash if the firm's assets are sold and all liabilities are paid
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comparable multiples |
-the amount that investors are willing to pay for each dollar of earnings -varies by industry |
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discounted cash flow analysis
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1) Determine asset's expected CF. 2) Choose discount rate reflecting asset's risk. 3) Calculate PV=PV cash inflows - PV cash outflows. |
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total dollar return |
total dollar return = income + K gain/loss
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Rt |
the percentage return on a stock between 2 periods (t and t-1) |
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_ R |
the average percentage return on a stock for a sample period of a time -arithmetic or geometrically calculated |
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diversification |
-reducing portfolio volatility by investing in many different assets
-the ups and downs of individual stocks partially cancel each other out -you can never diversify away all risk |
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standard deviation and diversification |
Diversification of risk means (ideally) less risk. SD measures total risk higher SD = higher risk SD of individual stock > SD of portfolio |
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total risk |
2 parts: 1) unsystematic risk=idiosyncratic, unpredictable 2) systematic risk=market risk, predictable, comes from owning a particular asset class. In a perfectly rational world, you would never be rewarded for unsystematic risk, only systematic risk. |
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historical approach to expected returns: definition, assumptions, limits |
look at past returns to guess about future
ASSUME: distribution of expected returns will be similar to historical distribution of returns LIMITS -may reflect the past more than the future -many stocks don't have a long-enough history to forecast expected return |
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probabilistic approach to expected returns: definition and limits |
identify all possible outcomes of returns and assign a probability to each outcome E(R) = p1(E1) + p2(E2) + ... + pn(En) LIMITS -still tied to historical data -requires analysts to specify possible future outcomes for stock return and attach a probability to each return |
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What is B? |
-slope of regression line measuring stock volatility
-measures the systematic risk for a particular security -represents the sensitivity of returns to investment (Ri) to changes in the overall market return risk-free asset B=0 market portfolio with every risky asset in the market B=1 |
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plotting stock volatility
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X-axis = market returns or market premium Y-axis=returns on investment (Ri) or extra returns earned above Rf from a stock (Ri - Rf) |
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Estimating B with regression
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^a = estimated intercept ^B=estimated slope epsilon =error term, idiosyncratic risk= assumed to equal 0 E(Ri) = Rf + ^B(Rm-Rf) |
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short selling |
borrowing a security and selling it to raise money to invest in something else -shows up as negative portfolio weight |
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What does a negative portfolio weight mean? |
It means the asset has been shorted. |
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Predictions and assumptions of CAPM |
PREDICTS: markets return to equilibrium ASSUMES: perfect competition, no arbitrage |
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security market line
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connects risk-free asset and the market portfolio
X-axis=B Y-axis=expected return If you're above the line, your asset was undervalued because it outperformed expectations. If you're below the line, your asset was overvalued, because it underperformed expectations. |
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predictions of security market line |
-in equilibrium, all assets lay on the line -If you're above the line, your asset was undervalued because it outperformed expectations. So investors drive up the price by bidding until the expected returns falls. -If you're below the line, your asset was overvalued, because it underperformed expectations. Investors drive down the price by selling until the expected returns rises. |
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attributes of CAPM |
-gives analysts a way to measure the systematic risk of an asset (so high-risks should earn high returns and vice versa) -allows us to compare risk and return between different potential investments |
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efficient market hypothesis -strong form -semi-strong form -weak form |
-stock prices reflect all available information -no arbitrage possible -strong form: information relevant to the stock -semi-strong form: publicly available information -weak form: information about past prices |
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fundamental analysis
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-includes economic analysis
-forward looking -tries to measure firm's "intrinsic value" -uses firm-specific, industry-specific, and economy-wide info ex) CAPM, FCF, dividends |
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long position |
to own an option or security
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short position |
to sell an option or security (because you're now short on them)
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technical analysis |
-backward-looking -tries to use supply and demand of a particular asset class -essentially, arguing that the efficient market hypothesis is untrue might also utilize: -past stock price and volume (moving averages, e.g.) -investor sentiments -charts and graphs (support and resistance) Examples: Dow Theory, support approach, moving averages approach |
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3 forces of Dow Theory
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1) primary trend 2) secondary reaction or trend 3) daily fluctuations Looks at Dow Jones Industrial Average and Dow Jones Transportation Average. |
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signals of Dow Theory |
Looks at Dow Jones Industrial Average and Dow Jones Transportation Average. If one index departs from the primary direction, NOT A SIGNAL. If both depart, it's a signal that the primary direction has changed. So if one departs, then the other must depart soon enough to confirm such a change. |
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support level |
-a level below which a stock's price isn't expected to drop, essentially a price floor -at the support level, there are more buyers and sellers, so the Qd > Qs -buyers are thus bargain hunters -you BUY at the support level |
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resistance level |
-level above which the stock's price isn't expected to rise, essentially a price ceiling -there are more sellers than buyers, so the Qs > Qd -sellers are thus profit-takers -you SELL at the resistance level |
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breakout |
when the stock price breaks through the support or resistance levels
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moving averages approach
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-calculates moving average of stock price
-common measures are 200 days, 50 days, and 15 days -MAt = (Pt + Pt-1 +...+ Pt-n-1) / t -if a shorter-term MA crosses a longer-term MA from above, you sell -if it crosses from below, you buy |
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What are the respective implications of the efficient market hypothesis's strong, semi-strong, and weak forms? |
-strong form: nobody consistently makes abnormal profits, so all analysis (fundamental and technical) is pointless -semi-strong: fundamental analysis is pointless -weak form: technical analysis is pointless |
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random walk theory |
-the theory that stock price changes have the same distribution and are independent of each other, so the past movement or trend of a stock price or market can't be used to predict future movement -the best prediction is today's price |
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Why are efficient financial markets not the same as perfect competition?
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-PC implies efficient markets, but not vice versa
ex) Bertrand price competition, where P=MC, but it's a duopoly -markets might be inefficient because of taxes, TCs, not many buyers/sellers (penny stocks), asymmetric info |
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Prospect Theory
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ISSUES: -value vs. utility=how we value losses vs. gains isn't symmetrical (losses hurt more than gains produce joy) -weighing or probability=rounding up or down can lead to systematic error -reference points=level matters -anchoring=highlights the importance of the inconsequential -representative heuristics=we tend to look for patterns because the narration or rule of thumb gives us confidence/comfort -social contagion/herd behavior |
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Why might alpha exist in the CAPM model? |
CAPM isn't saying that alpha shouldn't exist, but that it should eventually fade out
-size effects -momentum -seasonal effects -excessive volatility -overreactions -equity premium puzzle |
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derivative
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a security whose value is derived from the value of another asset's value
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economic functions of options and other derivative securities |
-help bring about more efficient risk allocation, resulting in better risk-return tradeoff -reduce TCs; it can be cheaper to trade a derivative than the underlying asset -allows investment strategies that would otherwise not be possible |
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intrinsic value of option |
-in the money: difference between S and X -out-of-the-money: 0 |
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time value of an option |
difference between option's intrinsic value and market price (premium)
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counterparty risk
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risk that the counterparty in an over-the-counter options transaction will default on its obligation |
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cash settlement |
one party pays the other the cash value of the option position, rather than actually buying or selling the underlying asset |
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naked option position |
trader buys or sells the option without actually owning underlying stock |
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long straddle |
a portfolio consisting of long positions in calls and puts on the same stock with the same strike price and expiration date |
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short straddle |
a portfolio consisting of short positions in calls and puts on the same stock with the same strike price and expiration date |
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put-call parity |
relationship that links market prices of stock, risk-free bonds, call options, and put options -bond payoff + call payoff = stock payoff + put payoff To prevent arbitrage opportunities, the portfolio price of the band and call option must equal the portfolio price of the stock and put option. -current stock price + current put option price = current bond price + current call option price |
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factors influencing option values
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price of underlying asset: -asset price and call price are positive related -asset price and put price are negatively related time to expiration: -more time=generally makes options more valuable (both call and put) -the longer time horizon includes all the stuff that happens in the shorter time horizon plus more time to potentially turn a profit or achieve a profit gain strike price -higher X=higher put price because you get to sell at X -lower X=higher call price -call prices rise and put prices fall when the difference between S-X increases interest rate -as r increases, bond prices fall, call option prices increase, and put prices fall |
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SD and options prices |
both call and put option prices increase as the volatility of the underlying stock increases |
