Intermediate Investments: Exam 1

Investment

the current commitment of money or other resources in the expectation of reaping future benefits.

Real Assets

Can be used to produce goods and services

Financial Assets

claims on real assets or the income generated by them.
Ex: Stocks and Bonds

Fixed-Income or Debt Securities

Promise either a fixed stream of income or a stream of income that is determined according to a specified formula.

common stock

- Represents an ownership share in the corporation
- Not promised a dividend

Derivative Securities

securities providing payoffs that depend on the values of other assets
- Options + Futures

asset allocation

portfolio choice among broad investment classes

security selection

choice of specific securities within each asset class

Top-down portfolio construction

starts with asset allocation

Security Analysis

involves the valuation of particular securities that might be included in the portfolio

Bottom up portfolio construction

the portfolio is constructed from the securities that seem attractively priced without as much concern for the resultant asset allocation

risk-return trade-off

the principle that the greater the risk a lender takes in making a loan, the higher the interest rate required

Diversification

Many assets are held in the portfolio so that the exposure to any particular asset is limited

Active Management

the attempt to improve performance either by identifying mispriced securities or by timing the performance of broad asset classes

Three Major Players in financial markets

Firms, households, governments

Firms are

Net demanders of capital

Households are

suppliers of capital

Governments are

borrowers or lenders

financial intermediaries

bring together the suppliers and demanders of capitals

Venture Capital

Equity investment in young companies

Private Equity Investments

Do not trade on public stock exchanges

Securitization

Pooling loans into standardized securities backed by those loans, which can then be traded like any other security.

Dodd-Frank Wall Street Reform and Consumer Protection Act

Contained mechanisms to mitigate systemic risk

Volcker Rule

Limited banks' ability to trade for own account

Bid Price

the slightly lower price you would receive if you wanted to sell a bill to a dealer

Ask Price

the price you would have to pay to buy a T-bill from a securities dealer

Bid-asked spread

the difference between the bid price and the asked price

Certificate of Deposit (CD)

A time deposit with a bank
- Cannot be withdrawn on demand

Commercial Paper

short-term unsecured debt issued by large corporations

London Interbank Offered Rate (LIBOR)

short-term interest rate quoted in the European Money Market

Money Market Funds

Mutual funds that invest in money market instruments

Treasury Inflation-Protected Securities (TIPS)

Treasury issues in which the principal amount is tied to the Consumer Price Index to protect the buyer against the effects of inflation

municipal bonds

tax-exempt bonds issued by state and local governments

Common Stocks

represent ownership shares in a corporation
- Residual Claim
- Limited Liability

preferred stock

stock that entitles the holder to a fixed dividend, whose payment takes priority over that of common-stock dividends.

Dow Jones Industrial Average

30 large, "blue-chip" corporations
- Price weighteed

Standard & Poor's Composite 500 (S&P 500)

A broadly based index of 500 firms. The S&P 500 is computed by calculating the total market value of the 500 firms in the index and the total market vsalue of those firms on the previous day of trading. The percentage increase in the total makret value from one day to the next represents the increase in the index

Call option

gives its holder the right to purchase an asset for a specified price, called the exercise or strike price, on or before some specified expiration date

Put option

the option to sell shares of stock at a specified time in the future

Futures contract

calls for the delivery of an asset at a specified delivery or maturity date for an agreed upon price called the futures price

Privately held company

owned by a relatively small number of shareholders
- fewer obligations to release financial statements and other information
- saves money
- frees the firm from disclosing info that could help a competitor

Initial Public Offering (IPO)

the first time a company issues stock that may be bought by the general public

Private Placement

Can sell shares directly to instituional or welathy investors

Seasoned Equity Offering (SEO)

the sale of additional stock by a company whose shares are already publicly traded

Underwriters

Investment bankers that market public offerings

Direct Listing

May be used for companies that do not need to raise cash immediately but want to be publicly traded

Direct Search Markets

Buyers and sellers locate one another on their own
- Craigslist

Brokered Markets

Brokers search out buyers and sellers
- Real Estate

Dealer Markets

markets in which traders specializing in particular assets buy and sell for their own accounts

Auction Market

a market where all traders meet at one place to buy or sell an asset
- NYSE

Market Orders

buy or sell orders that are to be executed immediately at current market prices

limit buy order

instructs the broker to buy some number of shares if and when they may be obtained at or below a stipulated price

limit sell order

instructs the broker to sell if and when the stock price rises above a specified limit

NASDAQ has how many levels?

3

Level 1

Receive only inside quotes but do not see how many shares are being offered

Level 2

Receive all bid and ask quotes but cannot enter their own quotes

Level 3

Market markers that can enter and change bid-ask quotes continually and have the fastest execution of trades

Algorithmic trading

the use of computer programs to make rapid trading decisions

high frequency trading

a subset of algorithmic trading that relies on computer programs to make very rapid trading decisions

Dark Pools

Trading venues in which the size and price of orders are not disclosed to participants. Prices are within the best bid and ask prices available in public markets, but traders face the risk their orders may not be filled if an excess of either buy or sell orders is received.

Margin

The portion of the purchase price contributed by the investor

Purchasing stock on margin

When investors buy stock with borrowed funds, this is sometimes referred to as

Margin Call

requires the investor to add new cash or securities to the margin account

Short Sale

Profit from a decline in a security's price

SIPC

ensures investors will receive securities held for their account by a failed brokerage firm

Inside information

private information held by officers, directors, or major stockholders that has not yet been divulged to the public

Fundamental Analysts

Use information concerning the current and prospective profitability of a company to assess its fair market value

Technical Analysts

Use trading data and trend analysis to uncover trading opportunities

Book Value

Net worth of the company as reported on the balance sheet

Market Value

Measures current values of assets and liabilities

Liquidation value per share

Amount of money that could be realized by breaking up the firm, selling assets, repaying debt, and distributing the remainder to shareholders

Tobin’s q

The ratio of market price to replacement cost

Capital Asset Pricing Model (CAPM)

Risk Free Rate+ Beta(MRP)

* Providing an estimated required rate of return

Replacement Cost

Cost to replace a firm’s assets

A “Fair” Return

Expected Return = Required Return

Intrinsic Value (Vo)

The present value of a firm’s expected future net cash flows discounted by the required rate of return

Market Capitalization Rate

The market-consensus estimate of the appropriate discount rate for a firm’s cash flows

Dividend Discount Model (DDM)

A formula stating that the intrinsic value of a firm equals the present value of all expected future dividends.

Constant-growth DDM, aka the Gordon Growth Model

A form of the dividend discount model that assumes dividends will grow at a constant rate.

Implications of Constant Growth Rate DDM

Stock value will be greater:

* The larger its expected dividend per share
* the lower the market capitalization rate, k
* the higher the expected growth rate of dividends

Dividend Payout Ratio

The fraction of earnings paid out as dividends

Plowback ratio

Fraction of earnings reinvested in the firm, also known as the earnings retention ratio

Sustainable Growth Rate

Growth rate of earnings and dividends if the firm reinvests a constant fraction of earnings and maintains both a constant return on equity and constant debt ratio.

Present Value of Growth Opportunities (PVGO)

Net Present Value of a firm’s future investments

Two-stage dividend discount model (DDM)

Dividend discount model in which dividend growth is assumed to level off to a steady, sustainable rate only at some future date.

Price-earnings multiple

The ratio of a stock’s price to its earnings per share

PEG Ratio

Ratio of P/E multiple to earnings growth rate.

Earnings Management

The practice of using flexibility in accounting rules to manipulate the apparent profitability of the firm

Price-to-Book Ratio

The ratio of price per share divided by book value per share

Price-to-Cash-Flow Ratio

The ratio of price to operating cash flow per share

Price-To-Sales Ratio

The ratio of stock price to the annual sales per share

WACC

Weighted average of the after-tax cost of debt and the cost of equity in each year

Earnings yield

Earnings per share divided by price per share

* Reciprocal of the P/E ratio