Finance Exam 5

Investing

The long-term process of purchasing securities wherein stability of value and level of return are somewhat predictable.

Risk Averse

Describes the average investor, requires higher returns as compensation for taking on higher risk. 

Primary Market

Trades new stock is issued for the first time. Investment bank underwrites, issuing company issues a prospectus and gets net proceeds. 

Secondary Market

Trades previously issued securities, including stock exchanges, NASDAQ, and the OTC market. 

Broker Market

Buyers and sellers come together at the exchange level, broker does not take ownership of the stock. Not as common

Dealer Market

Made up of many market makers/brokerage houses connected through a mass telecommunications network. Buyer and seller never meet, they set a bid and ask price. Essentially the retail market, includes JPMorgan Chase & CO + Charles Schwab.

Ask price

Investors pay this price when buying

Bid price

Investors receive this price when selling.

OTC Pink Sheets

Represent the unregulated segment of the market, where companies are not required to file with the SEC.

OTC Market

Regulated by the SEC, requires audited financial statements.

SEC

Primary agency that creates laws to protect investors, and requires disclosure of company data to prevent exploitation. Does the “policeing” of companies.

Dodd-Frank

Banks with assets from $100 billion to $250 billion are subject to stress tests(too big to fail). Banks with assets less than $10 billion are not subject to volker rule.

Volker Rule

Prevents banks from investing depositors fund in “risky investments”

Bull Market

A market condition satisfied when stocks are rising, more common.

Bear Market

A market condition satisfied when prices are falling, includes 2008 market, 2022 market. 

Full Service Broker

Type of Broker. Offers services including investment advice and information, trade
execution, holding securities for safekeeping, online brokerage services and margin loans.

Discount Broker

Type of Broker. Offers fewer service and less information, primarily executes trades, and has low fees. After a long partnership commission will be discounted.

Online Broker

Type of Broker. Executes trades via Internet and charges low fees.

SIPC

Provides protection against loss of securities or cash held by your broker, regulated by the SEC, but not an agency of the federal government. Ensures only the securities themselves will be returned, provides insurance for each account .

Day Traders

An investor who buys and sells stock rapidly throughout the trading day in hopes of making quick profit

Market Order

Type of Order: trade now at best available price

Limit Order

Type of Order: trade when a specified price or better is reached.

Stop Loss Order

Type of Order: sell if stock drops to a certain price, used to limit losses. Selling stock before it hits rock bottom.

Fractional Shares

Proportions of a single share of stock allowing investors to invest based on a specific dollar amount rather than having to buy full shares.

Portfolio

Collection of securities assembled for the purpose of meeting investment goals. Total return is influenced most by its asset location.

Margin Requirement

Amount of cash you have to put up to borrow the stock, usually 50% for common stock.

Buying on Margin

When the stock is sold, the borrowed shares are returned. You should only buy if stocks will go up in value. 

Short Sales

Made in anticipation of a decline in the price of a stock. When an investor sells, the broker borrows the security and sells it on behalf of the sellers account(securities they don’t own)

Annual report

Contains highlights of financial data, any bad information is found in the notes. 

Book Value Equation

Assets - Liabilities - Preferred stock

Book Value

The amount avaliable to common shareholders.

Net Profit Margin Equation

Net Profit / Sales

Net Profit Margin

The higher the margin the more money the company earns

Return on Equity Equation

Net income / shareholders equity

Earnings per share

Measure of earnings available to common stock shareholders on a per share basis. Can be compared to other corporations

Price Earnings Ratio Equation

Market price of common Stock / earnings per share

Price earning ratio

Measure of investor confidence and expectations, average ratio is about 15. If it is a lot higher than average for industry, stock may be overpriced.

Beta

An indication of a stocks price volatility, shows show responsive the stock is to changes in the overall stock market. Less than 1 = low price volatility, more than one = high price volatility.

1

Beta greater than this amount has high price volatility(riskier), beta lower than this amount has low price volatility.

Return on Equity

A measure of the firm’s overall profitability. Best ratio to look at to gauge finances. 

Business Risk

Variability surrounding the firms cash flows and the subsequent ability to meet bills on time

Financial Risk

Concerns the amount of debt used to finance the firm, ability of the firm to meet obligations on time

Market Risk

Behavior of investors in the market, reflected in the price volatility of a security(ex Target DEI backlash)

Purchasing Power Risk

Changes in the general level of prices can impact the ability of firm to operate. (ex: bird flu on eggs).

Interest Rate RIsk

Change in rate will impact fixed income securities such as bonds, when rate increases, value will decrease,

Liquidity Risk

Consumer risk of not being able to liquidate an investment conveniently and at a reasonable price. (ex: real estate).

Event Risk

The risk that a major, unexpected event will occur that leads to a sudden and substantial change in the value of an investment. (ex: war, covid)

Universal Rule of Investing

Rule stating if you want a higher level of return, you will have to accept greater exposure to risk. The only risk free rate is a treasury bill.

Blue Chips

Large, well established companies, tend to pay dividends with more stable resturns and less risk and beta in excess of 1. (ex: amazon, walmart)

Income

Stable earnings with regular, high dividends and betas less than 1.

Cyclical

Stock prices move in the same direction as the business cycle. Often these stocks are in basic industries and have a positive Beta.(ex car dealership)

Defensive

Stock expected to remain stable during times of contradiction in business activity. Called countercyclical, with betas less than 1. (ex: walmart and kroger)

Large Caps

Stock with a market value of more than 10 billion

Mid Caps

Stock with market value from between 2 - 10 billion. Provides stable return.

Small Caps

Stock with a market value of less than 2 billion. Has potential for high returns, greater risk than others, with growth potential.

Net Profit Margin Equation

Net Profit / Sales

Net Profit Margin

The higher the margin, the more money the company earns. Should be stable or better increasing.

3000

How much money can be used to offset ordinary income

Basic Tax Consideration

Gains on stock not taxed until realized by sale of stock.

Dividends

Determined by the firms board, paid quarterly.

Dividend Yield Equation

Annual dividend received per share / market price per share of stock

Dollar Cost Averaging

The investment strategy of purchasing an equal dollar amount of stock at equal intervals over time. Attempts to average out price variation by buying more shares when prices fall and fewer shares when prices rise. 

Common Stock

Paid Quarterly, has potential of high returns and high liquidity.

Bonds

An IOU, a liability to the issuer/corporation