Security Analysis Exam 1

Real assets have productive capacity to create goods and services, while financial assets are claims to the income generated by real assets.

What is the primary difference between real assets and financial assets?

The sum of all real assets in the economy

In a well developed economy, what constitutes ‘national wealth’?

Every financial asset is a claim held by one party that represents a financial liability to another party.

Why do financial assets cancel out when aggregating all balance sheets in an economy?

The choice among broad asset classes, such as stocks, bonds, or real estate.

What is the ‘asset allocation’ decision in the investment process?

The decision of which particular securities to hold within each chosen asset class.

What is ‘security selection’ in the context of portfolio construction?

top-down investment strategy

Which investment strategy starts with asset allocation before moving to individual security analysis?

conflicts of interest resulting from separation of ownership (stockholders) and management

what are ‘agency problems’ in modern corporations?

CFO and CEO

The Sarbanes-Oxley Act requires _______ to personally verify financial statements to improve corporate governance

Markets are efficient, and securities are generally neither underpriced nor overpriced.

What is the primary belief regarding markets held by proponents of ‘Passive Management’?

By earning money from interest rates paid to depositors and the rates charged to borrowers.

How do financial intermediaries, such as banks, generate profit?

They act as underwriters, purchasing new securities from issuers and reselling them to the public.

What is the role of an ‘investment banker’ in the primary market?

Originate-to-distribute model

2008 financial crisis

The practice of lenders selling mortgage loans to be bundled into mortgage-backed securities rather than holding them on their own balance sheets.

systemic risk

The risk of a breakdown in the entire financial system caused by spillover effects from one market to others

4,13,26, or 52 Weeks

The common maturities for Treasury Bills

360 day year

In a T-bill quote, the bank discount rate is calculated using this day count convention.

commercial paper

Short-term, unsecured debt notes issued by large, creditworthy corporations directly to the public

LIBOR

the rate at which large banks in London and elsewhere lend to one another.

London Interbank Offer Rate

Repurchase Agreement

A short-term collateralized loan where the borrower sells securities and agrees to buy them back at a higher price

Treasury Inflation Protected Securities

Bonds where the principal amount is adjusted based on changes in the Consumer Price Index.

Interest income is exempt from federal income taxation and usually from state and local taxation in the issuing state

What is the defining tax characteristic of municipal bonds

Stockholders are the last in line of all those who have a claim on the assets and income of the corporation

What does it mean for common stock to have a 'residual claim'?

Preferred stock pays a fixed dividend but does not usually grant voting rights

How does preferred stock differ from common stock regarding dividends?

Certificates traded in the U.S. representing ownership in shares of a foreign company

What are 'American Depositary Receipts' (ADRs)?

Price weighted Index

The Dow Jones Industrial Average is a…

Based on the total market value of the outstanding shares of each company

How does a market value-weighted index (like the S&P 500) determine the weight of a stock?

Call Option

The right to buy an asset at a specified price on or before a specified expiration date.

Put Option

The right to sell an asset at a specified price on or before a specified expiration date.

The commitment to purchase the underlying asset at the contract expiration for the set price

In a futures contract, what is the 'long' position?

The commitment to deliver the underlying asset at the contract expiration for the set price

In a futures contract, what is the 'short' position?

To provide a formal description of the firm and the security being issued to potential investors.

What is the purpose of a 'prospectus' in a public offering?

The first sale of stock by a formerly private company to the general public.

What is an 'Initial Public Offering' (IPO)?

A regulation allowing firms to preregister securities and sell them to the public at any time within the following two years.

What is the 'shelf registration' rule (SEC Rule 415)?

Auction Market

In which type of market do brokers and dealers trade in a single location with more or less continuous trading?

Bid Price

The price at which a dealer is willing to buy a security

Ask Price

The price at which a dealer is willing to sell a security

Limit Sell Order

An instruction to sell a stock if the price rises above a specified level.

Latency

The time it takes to accept, process, and deliver a trading order

Dark Pool

An electronic communication network where participants can buy or sell large blocks of securities anonymously

Initial Margin Requirement

The minimum percentage of the purchase price that the investor must contribute in equity, currently set at 50% by the Federal Reserve

Maintenance Margin Requirement

The minimum level of equity that must be kept in a margin account before a margin call is triggered

The broker notifies the investor to add funds to the account or have the securities liquidated to cover the loan

What happens when an investor receives a 'margin call'?

Short Sale

The sale of shares not owned by the investor, borrowed through a broker, with the goal of buying them back later at a lower price

Insider trading

The illegal practice of trading on nonpublic knowledge about a corporation possessed by individuals with privileged access to that information

Net Asset Value

The market value of the fund's assets minus its liabilities, expressed on a per-share basis

Open-end funds issue or redeem shares at launch, while closed-end funds have a fixed number of shares that trade on exchanges like stocks.

How do 'Open-end' funds differ from 'Closed-end' funds regarding share count?

Unit investment trust

A pool of money invested in a fixed portfolio that is unmanaged for the life of the fund.

To allow the fund manager to invest in illiquid assets without the risk of sudden redemptions by investors.

Why do hedge funds often have 'lock-up' periods?

12b-1 fees

Annual fees charged by mutual funds to pay for marketing and distribution costs.

exchange traded funds

Offshoots of mutual funds that allow investors to trade index portfolios like shares of stock throughout the day

Store of Value

The ability of a currency to hold its purchasing power over a reasonable timeframe.

Unit of Account

A standard measuring tool used to compare the relative values of different goods and services.

Commodity money

Money that has intrinsic value, such as gold coins or cigarettes in a POW camp.

fiat currency

Money that has no intrinsic value and is not linked to a physical commodity, but is declared legal tender by a government.

legal tender

It must be accepted within a jurisdiction as a valid payment for all debts, public and private.

coincidence of wants

The unlikely situation where two people happen to have exactly what the other wants at the same time and place

Inflation

According to the crypto source, what is the 'silent thief' that destroys wealth?

Digital money transfers must be managed by a third party (like a bank), whereas cash can be transferred directly between individuals.

How does digital money differ from physical cash regarding third parties?

representative money

Money that has no intrinsic value itself but represents a claim on a valuable underlying asset, such as a warehouse receipt for gold.

The phenomenon where the initial offer price is set lower than the market's valuation, often resulting in a large first-day price jump.

What is underpricing in the context of an IPO

underwriting syndicate

A group of investment bankers formed to share the responsibility and risk of marketing a new security issue.

marking to market

The daily process of adjusting the margin account balance to reflect profits or losses resulting from changes in the futures price.

Investors who receive an allocation of shares in a highly desired IPO may find the shares were only available because more informed investors avoided them

Why is the 'Winner's Curse' associated with IPOs?

real estate investment trusts

Investment vehicles similar to closed-end funds that invest in real estate or loans secured by real estate

fixed rate debtors,

governments with large nominal debts

owners of real assets like land

who benefits from inflation?

consumers

people who are spending their money for goods and services are hurt by raised prices as the value of money stays the same.

who is hurt by inflation?

4 houses model

the more money that is printed and in circulation, the more prices rise. more money printed can cause inflation.

what causes inflation?

people would take their coin currency to a security bank and they were given a reciept in return that represented their money.

how did jiaozi work?

it initially stimulated trade and eased monetary constraints, but later contributed to inflation and fiscal strain when overissued.

what was the economic consequence of the jiaozi?

the separation of ownership and control, which creates information asymmetry and divergent goals between the principal and the agent, enabling the agent to act in self‑interest rather than the principal’s best interest

what is the root cause of an agency problem?

performance based compensation

board of directors oversight

threat of proxy

oversight by outsiders

threat of corporate takeover

what are ways to mitigate agency problems?

Property (Land)

Labor (skills, time, people)

Ideas (what you think, speech, decision making)

Captial (money, how you spend it)

What are the factors of production?

You cannot have socialism in a democratic society, democracy needs capitalism in order for freedom to be an option.

what did milton friedman say about capitalism and socialism?

prices of all stocks in index/divisor

What is the price-weight index equation?