BFIN3020 CH 13

Fundamental analysis

securities analysis based on company financial statements and economic conditions that affect the company’s business

Technical Analysis

a method of evaluating securities by studying investor attitudes and psychology, as revealed through historical price movement and volume.

Fundamental Analysis

focuses on the intrinsic value of a security

Technical Analysis

focuses on future price movements

efficient market hypothesis

the theory that a stock’s price reflects all available information, suggesting that it is impossible to consistently achieve higher returns than the overall market.

random walk theory

new information is revealed about a stock randomly over time, past price changes contain no useful information because any developments affecting the company are already reflected in the price.

rational expectations hypothesis

people use information intelligently in their own self interests and make intelligent decisions after weighing important information. past mistakes are avoided using available information to anticipate change.

3 Variations of EMH

weak, semi-strong, strong

weak form EMH

states that all past trading information is already reflected in stock prices, implying that technical analysis is useless.

semi-strong form EMH

states that all publicly available information is reflected in stock prices, suggesting that neither fundamental nor technical analysis can provide an advantage.

strong form EMH

states that all information, both public and private, is fully reflected in stock prices, meaning that no single investor has an advantage over another.

causes for capital market inefficiency

new information is not available to everyone at the same time, and investors do not react in the same way to the same information.

causes for capital market inefficiency

not everyone can make accurate forecasts and correct valuation decisions. Mass investor psychology and greed may at times cause investors to act irrationally.

3 categories of macroeconomic factors that affect investor expectations

fiscal policy, monetary policy, inflation

2 most important tools of fiscal policy

government spending/expenditure and taxation

what factor limits the effectiveness of fiscal policy

the time lag to get parliamentary approval for tax legislation, and the time lag between when the fiscal action is taken and its impact on the economy is felt.

what effect does an increase in government spending have?

stimulates the economy in the short run.

what effect does an increase in taxes have?

lowers consumer spending and business profitability which can lead to decreased economic growth and investment.

what effect does a decrease in taxes have?

increases consumer spending and boosts business profits/common share prices, which can stimulate economic growth and investment.

what effect does a high level of government debt have?

Limits the options for fiscal and monetary policy, and can lead to increased interest rates, slower rate of economic growth, and lower corporate profits (less investment).

what is the primary role of the Bank of Canada

to regulate monetary policy. preserves Canadian dollar by keeping inflation low, stable, and predictable.

if the economy is slowing down, the Bank of Canada will do what?

increase the money supply by lowering interest rates, to encourage borrowing and spending.

what effect does high inflation have on share prices?

lowers share prices

4 stages of industry life cycle

emerging growth, growth, maturity, decline.

software and hardware development in the computer industry indicates which stage in the industry life cycle?

emerging growth

emerging growth companies

unprofitable at first, large start up investments, possibly negative cash flows.

growth industry

Above average rate of earnings on invested capital over a period of several years. Can maintain/get better earnings, lower production costs, increased competition, rising demand, growth in profits.

growth industry

companies have high price-earnings ratios, low dividend yields.

mature industries

slower, stable growth in earnings, more closely matches the overall rate of economic growth.

mature industries

experience increased price competition, profit margins fall.

mature industries

can withstand market fluctuations and economic downturns due to established market positions.

declining industries

demand for their products has declined due to technology changes, an inability to compete on price, and consumer preferences.

declining industries

large cash flow, low profits.

Porter’s 5 Forces.

Threat of new entry, competitive rivalry, threat of substitutes, bargaining power of buyers, bargaining power of suppliers.

cyclical industry

sensitive to swings in economic conditions.

types of cyclical industries

Commodities, Industrial cyclical, Consumer cyclical

commodity basic cyclical

lumber, base metals, oil, chemical industries

industrial cyclical

transportation, capital goods, basic industries.

consumer cyclical

merchandising, automobile industries

defensive industries

blue chip, stable returns, less sensitivity to economic cycles.

defensive industries

banks, utilities. (Both are sensitive to interest rates though)

speculative industry

high risk and uncertainty due to limited financial information.

support level

the bottom price of the trading range. Demand > supply. Prices will rise.

resistance level

top price of the trading range, supply > demand. prices will fall.

reversal pattern

chart formations that indicate a sizeable change in the direction of a trend.

head and shoulders top formation

a type of reversal pattern that occurs at a market top, indicating a potential trend reversal from bullish to bearish.

head and shoulders bottom formation

a type of reversal pattern that occurs at a market bottom, indicating a potential trend reversal from bearish to bullish.

a downward breakout from the neckline indicates

prices will go down (sell signal)

an upward breakout from the neckline indicates

prices will go up (buy signal)

continuation pattern

a chart pattern that indicates the prevailing trend is likely to continue after a brief pause.

symmetrical triangle

a continuation pattern characterized by converging trendlines that signal a potential breakout in either direction.

quantitative analysis

form of technical analysis that relies on statistics.

moving average

a quantitative analysis tool that smooths price data by creating a constantly updated average price. It helps identify the direction of the trend and potential reversal points.

cycle lengths

long term, seasonal, primary/intermediate, trading

long term cycle length

>2 years

seasonal cycle length

1 year

primary/intermediate cycle length

9-26 weeks

trading cycle length

4 weeks

One might invest in cyclical industries if…

Canadian dollar is forecasted to decline

if economic growth accelerates, what happens to bond yields?

rise

what changes the yield curve

increase in short term interest rates