Study guide

Weak-form - past prices and volume offer no advantage in beating the market. Semistrong-form, where publicly available information cannot be used to consistently earn excess returns.

Strong-form - Any information, public or private, is useless for beating the market.

(Market Efficiency Requirement) Rational - they won't systematically misprice assets, making it difficult to earn excess returns.

(Market Efficiency Requirement) Independent - Even if many investors are irrational, their deviations may be independent and cancel each other out.

(Market Efficiency Requirement) The existence of arbitrageurs - Well-capitalized and rational, so they can correct mispricings.

Informed Trading - Occurs when investors make decisions based on publicly available information and analysis. This public information can come from sources like financial reports or news.

Legal insider trading - When company insiders trade their own stock, provided they use only public information and follow SEC reporting rules.

Illegal insider trading - Involves trading based on information not known to the public that would affect the stock price.

Main role of a portfolio manager - Build a portfolio specifically tailored to the individual needs of investors. This involves considering factors like the investor's age, tax bracket, risk tolerance, and even their employer. The goal is to create a portfolio that meets the client's unique situation, rather than trying to outperform the market.

Market anomalies - Aspects of stock price behavior that researchers find baffling and potentially hard to reconcile with market efficiency.

Behavioral finance - Field studying how reasoning errors influence investor decisions and market prices.

Prospect theory - Investors are much more upset by potential losses than they are happy about similar gains. It also highlights that people tend to focus on changes in their wealth rather than its overall level.

Frame dependence - Investors make inconsistent choices depending on how an identical problem is presented or phrased.

Loss aversion - Reluctance to sell investments that have fallen in value, essentially fixating on the original purchase price and feeling more pain from losses than joy from equivalent gains. The house money effect - Investors being more willing to take risks with money they perceive as winnings or "windfall" compared to their initial capital.

Illusion of knowledge - Investors believe their own information is superior to others', leading to overconfident investment judgments.

Snakebite effect - Investors becoming unwilling to take risks after experiencing a loss, decreasing their confidence.

Hot-hand fallacy - Belief that recent random streaks make future success more likely

Gambler's fallacy - The error of assuming a random event is more likely because it hasn't happened recently, like thinking it is overdue.

Treasury yield curve - Shows how interest rates on government bonds change based on how long until they mature. The term structure of interest rates describes this relationship specifically for simple debt without coupons.

Expectations Theory - where rates reflect future rate beliefs.

Market Segmentation Theory - viewing different maturities as separate markets.

Maturity Preference Theory - Argues lenders want a premium for longer loans.

Modern Theory - Argues lenders want a premium for longer loans and adds premiums for inflation, interest rate risk, liquidity, and default risk.

Callable bond - gives the issuer the option to buy back the bond at a specified call price anytime after an initial call protection period.

Convertible bond - can be exchanged by the bondholder for a fixed number of shares of the issuing company’s stock.

Putable bond - allows the bondholder to sell the bond back to the issuer at a set price before maturity.

Private Equity - a form of investment where funds are directly invested into nonpublic companies or buyouts of public companies, often involving a higher risk but with potential for greater returns.

Leveraged Buyout - a financial transaction in which a company is purchased with a combination of equity and significant amounts of borrowed funds, enabling the acquirer to use the company’s assets as collateral for the loans.

Taking the Company Private - this refers to the process of purchasing all outstanding shares of a publicly traded company, resulting in its delisting from public stock exchanges and allowing greater control and flexibility for the new owners.

Primary market - the market where new securities are issued and sold to investors, providing companies with capital to fund their operations and growth initiatives.

Secondary market - the market where previously issued securities are bought and sold among investors, allowing for liquidity and price discovery of financial instruments.

Initial Public Offering (IPO) - the process through which a private company offers shares to the public for the first time, transforming from a privately owned entity to a publicly traded one.

Seasoned Equity Offering - the reissuing of shares by a company that is already publicly traded, allowing it to raise additional capital while providing existing shareholders with opportunities to diversify their investments.

Market order - a request to buy or sell a security at the current market price, ensuring immediate execution but without a specified price limit.

Limit order - an order to buy or sell a security at a specified price or better, allowing investors to have more control over the price at which the transaction occurs.

Stop order - an order to buy or sell a security once it reaches a specified price, which helps limit losses or lock in profits; once the stop price is reached, the stop order becomes a market order.

Stop order limit - Triggered when a specified stop price is reached, but it will only execute at a specified limit price or better, offering more control over execution than a regular stop order.

Level 1 circuit breaker - a temporary halt in trading that occurs when a stock's price drops by a 7%, designed to prevent panic-selling and allow time for information dissemination.

Level 2 circuit breaker - a more severe trading halt that is triggered when a stock's price declines by 13%, providing additional time for investors to assess the situation and make informed decisions.

Level 3 circuit breaker - initiates a trading halt for the remainder of the day when a stock's price falls by 20%, aimed at preserving market stability and preventing extreme volatility.

Fundamental analysis - studying a company’s accounting statements and other financial and economic information to estimate the economic value of a company’s stock.

Technical analysis - a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume, to forecast future price movements.

Free Cash Flow - the cash generated by a company that can be used for expansion, dividends, reductions in debt, or other corporate purposes after accounting for capital expenditures.

FCF= EBIT (1 – Tax Rate) + Depreciation – Capital Spending – Change in Net Working Capital

Enterprise value - Measure of a company's total value. It represents the theoretical cost of acquiring a company, including its equity and debt obligations, while subtracting any cash or cash equivalents the company holds.

Prime Rate - The basic interest rate on short-term loans that the largest commercial banks charge to their most creditworthy corporate customers.

Fed Funds Rate - The federal funds rate is the interest rate at which depository institutions (like banks) lend reserve balances to each other overnight.

Federal Reserve Discount rate - The interest rate that the Fed offers to commercial banks for overnight reserve loans.

Pure Discount Security - interest-bearing asset that makes a single payment of face value at maturity and makes no payments before maturity

STRIPS - pure discount instruments created by “stripping” the coupons and principal payments of U.S. Treasury notes and bonds into separate parts, which are then sold separately.

Annual Percentage Rate (APR) - A method to quote interest rates, sometimes referred to as a "simple" interest basis. They are calculated just like annual percentage rates.

Effective Annual Rate (EAR) - The "true interest rate" because it accounts for the effect of compounding.

Inflation Protected bonds - Designed to guarantee a fixed rate of return in excess of realized inflation rates. These securities pay a fixed coupon rate on their principal, but the principal itself is adjusted semiannually according to the most recent inflation rate. Also referred to as TIPS: Treasury Inflation-Protected Securities

Implied forward interest rates - An expected rate on a short-term security that is originated at some point in the future. These rates are not observed directly in the market today for future periods, but are implied or derived from the current term structure of interest rates.

Premium bonds - The coupon rate is greater than the YTM. This occurs when the bond's Price is greater than its Face value.

Discount bonds - The coupon rate is less than the YTM. This occurs when the bond's Price is less than its Face value.

Par bonds - The coupon rate is equal to the YTM. This occurs when the bond's Price is equal to its Face value.

How to offset risk correlation coefficient - Diversification, find assets whose returns offset each other to some degree, less correlated the assets the more effective it is at reducing risk, combine different asset classes.

Efficient frontier - Any portfolio that does not lie on this frontier is considered inefficient. Investors should not choose these inefficient portfolios because they could achieve either a higher expected return for the same amount of risk or the same expected return with less risk by selecting a portfolio on the efficient frontier.