Study guide

Weak-form efficiency

Past prices and volume offer no advantage in beating the market.

Semistrong-form efficiency

Publicly available information cannot be used to consistently earn excess returns.

Strong-form efficiency

Any information, public or private, is useless for beating the market.

Market efficiency requirement - Rational

Investors won't systematically misprice assets, making it difficult to earn excess returns.

Market efficiency requirement - Independent

Even if many investors are irrational, their deviations may cancel each other out.

Market efficiency requirement - Existence of arbitrageurs

Well-capitalized and rational investors who can correct mispricings.

Informed trading

Investors make decisions based on publicly available information and analysis.

Legal insider trading

Company insiders trade their own stock using only public information and following SEC rules.

Illegal insider trading

Trading based on information not known to the public that can affect stock prices.

Role of a portfolio manager

To build a portfolio tailored to individual investor needs considering various personal factors.

Market anomalies

Aspects of stock price behavior that are hard to reconcile with market efficiency.

Behavioral finance

Study of how reasoning errors influence investor decisions and market prices.

Prospect theory

Investors are more upset by potential losses than they are happy about similar gains.

Frame dependence

Investors make inconsistent choices based on how a problem is presented.

Loss aversion

Reluctance to sell investments that have fallen in value, fixating on the purchase price.

House money effect

Investors take more risks with perceived winnings compared to initial capital.

Illusion of knowledge

Investors believe their own information is superior, leading to overconfidence.

Snakebite effect

Investors become unwilling to take risks after experiencing a loss.

Hot-hand fallacy

Belief that recent random successes make future success more likely.

Gambler's fallacy

Assuming a random event is overdue because it hasn't occurred recently.

Treasury yield curve

Shows how interest rates on bonds change based on maturity duration.

Expectations theory

Rates reflect expectations of future interest rates.

Market segmentation theory

Viewing different maturities as separate markets.

Maturity preference theory

Lenders want a premium for longer loans.

Callable bond

Bond that gives the issuer the option to buy it back at a specified price after a period.

Convertible bond

Bond that can be exchanged for a fixed number of the issuing company’s stock shares.

Putable bond

Bond allowing the holder to sell it back to the issuer at a set price before maturity.

Private equity

Investment in nonpublic companies or buyouts of public companies, often high risk.

Leveraged buyout

Company purchase using both equity and borrowed funds, using assets as collateral.

Taking the company private

Purchase of all outstanding shares to allow greater control and flexibility.

Primary market

Market where new securities are issued, providing capital to companies.

Secondary market

Market for previously issued securities, allowing liquidity and price discovery.

Initial Public Offering (IPO)

Process of a private company offering shares to the public for the first time.

Seasoned Equity Offering

Reissuing shares by a company already publicly traded to raise additional capital.

Market order

Request to buy or sell a security at the current market price for immediate execution.

Limit order

Order to buy or sell a security at a specified price or better for more control.

Stop order

Order to buy or sell once a specified price is reached to limit losses or lock in profits.

Stop order limit

Triggered at a stop price but executes only at a specified limit price or better.

Level 1 circuit breaker

Temporary trading halt when a stock's price drops by 7% to prevent panic-selling.

Level 2 circuit breaker

More severe halt triggered when a stock's price declines by 13%.

Level 3 circuit breaker

Trading halt for the day when a stock's price falls by 20%.

Fundamental analysis

Studying financial statements to estimate a company’s stock economic value.

Technical analysis

Evaluating securities by analyzing market-generated statistics to forecast price movements.

Free cash flow

Cash generated by a company after accounting for capital expenditures.

Enterprise value

Measure of a company's total value, representing the cost of acquiring the company.

Prime rate

The basic interest rate on short-term loans charged by banks to their best customers.

Fed funds rate

Interest rate at which banks lend reserve balances to each other overnight.

Federal Reserve discount rate

Interest rate the Fed offers to banks for overnight reserve loans.

Pure discount security

Asset making a single payment of face value at maturity with no prior payments.

STRIPS

Pure discount instruments created by separating the coupons and principal payments of U.S. Treasury securities.

Annual Percentage Rate (APR)

Method to quote interest rates based on simple interest calculations.

Effective Annual Rate (EAR)

Accounts for compounding to reflect the true interest rate.

Inflation-protected bonds

Bonds that guarantee a fixed return over inflation, known as TIPS.

Implied forward interest rates

Expected rates on short-term securities originated in the future, derived from current rates.

Premium bonds

Bonds priced higher than face value, with coupon rates greater than YTM.

Discount bonds

Bonds priced lower than face value, with coupon rates less than YTM.

Par bonds

Bonds priced at face value, with coupon rates equal to YTM.

Offsetting risk with correlation coefficient

Diversification, find assets whose returns offset each other to some degree, less correlated the assets the more effective it is at reducing risk, combine different asset classes.

Efficient frontier

Any portfolio that does not lie on this frontier is considered inefficient. Investors should not choose these inefficient portfolios because they could achieve either a higher expected return for the same amount of risk or the same expected return with less risk by selecting a portfolio on the efficient frontier.

Duration

Calculates the weighted average time it takes to recover the initial investment through the bonds coupon payments.