Investing Chapter 1 & 2 (Week 1- Sept.8/26)

Investment Environment & Securities Markets

What is the primary market?

• New securities are sold by the issuer to investors.

• The issuer receives the money.

What is the secondary market?

• Existing securities are traded between investors.

• The company normally does not receive new money.

What is the money market?

Market for:

• short-term debt securities

• generally less than 1 year

What is the capital market?

Market for:

• stocks

• longer-term debt securities

What does it mean to take a long position?

1. Buy a security first

2. expecting its price to rise

3. then sell for a profit

What does buying on margin mean?

Borrowing part of the purchase price from a broker to buy securities.

What is a short sale?

1. Borrow shares

2. sell them

3. buy them back later at a lower price

4. return the shares

The short seller profits if the price falls.

What is the major risk of short selling?

Potential losses are unlimited because a stock's price can keep rising.

What is a margin call?

Investor's equity falls below required maintenance margin.

What is the formula for margin percentage?

Margin % = Equity ÷ Market Value

What happens after a margin call?

• Investor generally must add money or reduce/sell the position

• restore the required maintenance margin

What is the bid price?

The price at which a dealer is willing to buy.

What is the ask price?

The price at which a dealer is willing to sell.

What is the bid-ask spread?

• Ask − Bid

What is an IPO?

An Initial Public Offering — the first public sale of a company's shares.

Does an IPO occur in the primary or secondary market?

Primary market.

What is "money left on the table" in an IPO?

The amount the company could have raised if it had sold the shares at the first-day closing price instead of the IPO offer price.

What is the formula for IPO money left on the table?

(First-day closing price − IPO offer price) × number of shares

What is diversification?

Spreading investments across different assets to reduce the effect of one poorly performing asset.

What type of risk does diversification help reduce?

Concentration/specific risk.

Does diversification eliminate all risk?

No. It does not eliminate market risk or guarantee a profit.

What is the risk-return tradeoff?

Higher expected returns generally require accepting greater uncertainty/risk.

Does higher risk guarantee a higher return?

No. It means investors generally require/expect more return for accepting more uncertainty.

What does owning common stock mean?

You are an owner/shareholder of the company.

How can a stockholder earn a return?

Through dividends + capital gains/losses.

What does owning a bond mean?

You are a lender/creditor to the issuer.

How can a bond investor earn a return?

Through interest/coupon payments + changes in the bond's value.

What is a nominal return?

Return before accounting for inflation.

What is a real return?

Return after accounting for inflation.

What is the approximate real return formula?

Real return ≈ Nominal return − Inflation

What happens to purchasing power when inflation is high?

It reduces the purchasing power of your returns.

What is an investment?

Funds committed to an asset with an expectation of income or growth.

What are the two basic components of investment return?

Income + capital gain/loss.

What does HPR stand for?

Holding Period Return.

What is the HPR formula?

HPR = (Income + Capital Gain/Loss) ÷ Beginning Value

How do you calculate a capital gain?

Ending value − Beginning value

What is a direct investment?

You directly own the asset/security.

What is an indirect investment?

You invest through a fund that owns the underlying securities.

What is an Investment Policy Statement (IPS)?

A document that records:

• investment goals

• risk tolerance

• constraints

• investment guidelines

What does an IPS NOT do?

It does not predict the market or guarantee returns.

What does liquidity mean?

Easily an investment can be bought or sold with limited price impact.

What are the four dimensions of liquidity?

1. Tightness

2. depth

3. immediacy

4. resiliency

Why can extended-hours trading be riskier?

Lower liquidity can lead to wider spreads and greater price uncertainty.

What does a broker do?

Matches buyers and sellers.

What does a dealer do?

Trades from its own inventory and quotes bid/ask prices.

What extra risk comes with international investing?

• Currency risk

Plus:

• political

• tax

• accounting

• market-hour differences

How can currency movements affect your return?

Your return in CAD can be lower or higher than the foreign-currency return depending on exchange-rate changes.

What is a realized gain/loss?

A gain or loss that occurs after you sell the investment.

What is an unrealized gain/loss?

A gain or loss on an investment that you still hold.

What is the difference between investment income and a capital gain?

• Investment Income: money received while holding an investment, such as dividends, interest, or rent.

• Capital gain/loss: a change in the investment's value.