investments 2

NYSE value

$20.2 trillion

middle market

-where small regional private equity funds concentrate investments -known performance history -small, family owned

NASDAQ

nat'l association of securities dealers auto quotations system -more companies than NYSE, lower total mkt cap

IPO and SEO steps

-company appoints investment banking firm to arrange financing -investment bank designs stock issue and arranges sale -company prepares a prospectus and submits it to the SEC for approval

reasons middle market seek more capital

-expansion beyond existing region -founder wants to 'cash out'

min requirements to apply fro NYSE listing

-number of shareholders -trading activity -number and value of shares held in public hands -annual earnings

bid price

-price dealers pay investors when buying -price investors receive when selling

ask price

-price dealers receive from investors when selling -price investors pay dealers when buying

to limit risk, venture capitalists...

-provide financing in stages -actively help run the company

market order

-specify ticker and quantity buy executed at lowest ask sell executed at highest bid

limit order

-specify ticker, quantity, price buy executed at limit or lower sell executed at limit or higher

how do prospect theory and the concept of rational investor differ?

-the focus on gains and losses, combined with the tendency of investors to be risk-averse with regard to gains, but risk-taking when it comes to losses, is the essence of prospect theory -a fully rational investor is presumed to only care about his or her overall wealth, not the gains and losses associated with individual pieces of that wealth

buy stop

-use when you have a *short* position and want to protect from price rise -will be above current stock price

sell stop order (stop loss)

-when you have a *long* position and want to protect from price decline -will be below current stock price -risk: price suddenly plummets and position is liquidated at a large loss

Managers can increase the sustainable growth rate by:

-Increasing profitability (Net Income / Sales) -Increasing asset efficiency (Sales / Assets) -Increasing debt (Assets / Equity) -Decreasing the dividend payout ratio

russell 2000

next 2000 largest public equities outside of largest 1000 "small cap" stocks

Private equity funds generally have:

-a high water-mark provision -a "clawback" provision - "opportunity to "clawback" Profits if future downturn

FCF

-calculate value for firm -FCF can be paid to debt holders and to stockholders -can still calculate value of equity using FCF -need beta for assets

DDMS

-calculate value of equity only -use dividends -use CAPM -use equity beta for risk

growth rate in dividends can be estimated in 3 ways

1. Using the company's historical average growth rate. 2. Using an industry median or average growth rate. 3. Using the sustainable growth rate.

3 economic conditions that lead to market efficiency

1. investor rationality 2. independent deviations from rationality 3. arbitrage

inefficient market can't have

1. many investors make irrational investment decisions 2. collective irrationality of these investors leads to an overly optimistic or pessimistic market situation 3. situation can't be corrected via arbitrage by rational investors

indexes distinguished in 4 ways

1. market covered 2. types of stocks included 3. how many stocks included 4. how index is calculated

standard and poors 500

500 largest public equities "large cap" stocks -value weighted

frame dependence

If an investment problem is presented in two different ways, investors often make two different choices -how a problem is described (or framed) seems to matter to people

sustainable growth rate

ROE * retention ratio RR= 1-payout ratio

loss aversion

a reluctance to sell investments after they have fallen in value AKA "breakeven" effect or "disposition" effect

chartists

aka technical analysts study graphs of past market prices to identify chart formations

suppose you're flipping a fair coin and you have flipped 8 heads in a row. what is the prob of flipping a head on the next coin flip? suppose you flipped a head on the 9th toss, what's the prob of flipping a head on the 10th?

as long as it's a fair coin, the probab in both cases is 50% as coins have no memory. although many believe the probability of flipping a tail would be greater given the long run of heads, this is an example of the *gambler's fallacy*

anchoring

associating a stock with its *purchase price* fixating on an initially provided value

the fundamental business of the NYSE is to

attract and process *order flow*

you invest $10,000 in the market at the beginning of the year, and by the end of the year your account is worth $15,000. during the year the market return was 10%. does this mean that the market is inefficient?

beating the market during any year is possible. if you can consistently beat the market, it may shed doubt on market efficiency unless you're taking more risk that the market as a whole or you're just lucky. Before any conclusion is made, we would want to control for the amount of risk in your portfolio

Clean Surplus Relationship (CSR)

change in book value per share is equal to earnings per share minus dividends

P/E ratio

cur stock price / annual earnings per share (EPS)

bid-ask spread (dealers compensation)

difference between bid and ask price

dark pool

direct trading between 2 entities to avoid bid-ask spread

broker said 'well-managed firms are better investments' as evidence, he cited a study of 100 small manufacturing firms that 8 years earlier had been listed as the best managed in the country. in those 8 years, the 100 listed have not earned more than normal market return. he continued to say that if the firms were well managed, they should have produced better than avg returns. if the market is efficient, do you agreee?

do not agree. performance ratings of the small firms were published and public info. prices should adjust immediately to the info, preventing future abnormal returns

several celebrated investors and stock pickers have recorded huge returns on their investments over the past 2 decades. is the success of these particular investors an invalidation of an efficient stock marker?

efficient markets paradigm only says, within the bounds of increasingly strong assumptions about the information processing of investors, that assets are fairly priced. An implication of this is that, on average, the typical market participant cannot earn excess profits from a particular trading strategy. However, that does not mean that a few particular investors cannot outperform the market over a particular investment horizon. Certain investors who do well for a period of time get a lot of attention from the financial press, but the scores of investors who do not do well over the same period of time generally get considerably less attention.

CAPM

estimates the discount rate for a stock

the efficient markets hypothesis implies that all mutual funds should obtain the same expected risk-adjusted returns. therefore, we can simply pick mutual funds at random. is this true or false?

false bc every investor has a dif risk preference. although the expected return from ever portfolio is the same after adjusting for risk, investors still need to choose funds that are consistent with their particular risk level

venture capital

financing new, often high-risk, start-ups

super bowl indicator

forecasts direction of the market based on who wins the superbowl NFC win considered *bullish*

growth stocks vs value stocks

high p/e stocks, low p/e stocks

seasoned equity offering (SEO)

if a company already has public shares, an SEO occurs when a company raises more equity

what are the implications of the efficient markets hypothesis for investors who buy and sell stocks in an attempt to 'beat the market'?

ignoring trading costs, such investors earn what the market offers; the trades all have 0 NPV. if trading costs exist, then these investors lose by the amount of the costs

what is the illusion of knowledge? how does it impact investment performance

illusion of knowledge suggests that you believe the info you hold is better than that held by other investors. therefore, you become overconfident and believe your investment choices are better

implementation costs

include transaction costs such as bid-ask spreads, brokerage commissions, and margin interest

dow jones ind avg (DJIA)

index of stock prices of 30 large companies -price weighted

earnings yield

inverse of P/E ratio EPS/pps

individual venture capitalists

invest their own money -know many new companies fail

secondary market

investore trade previously issued securities

prospect theory

investors are much more distressed by prospective losses than they are happy about prospective gains -people focus on changes in wealth vs levels in wealth

primary market

investors buy newly issued securities

backtesting

investors can derive thousands of potentially successful technical analysis systems by using historical security prices

today, the following announcement was made: 'early today the justice dept reached a decision in the UPC case, they were found guilty in discrimination. for the next 5 years, UPC must pay $2mil/year to fund victims.' assuming the market is efficient, should investors not buy UPC stock after this because of the litigation?

it shouldn't deter investors. if the market is semi stron, the stock price will have already reflected the PV of payments that UPC must make. the expected return after the announcement should still be equal to the expected return before the announcement. UPC's current stockholders bear the burden of the loss, since the stock price falls at announcement. after, the expected return moves back to the original level

asset betas

measure risk of company's industry

briefly explain mental accounting and identify the potential negative effect of this bias

mental accounting is when investors trat each investment seperately as opposed to considering the overall wealth og their portfolios. this bias may induce investors to sell winners too early and keep losers too long

dividend discount model

method to estimate the value of a share of stock by discounting all expected future dividend payments P0= D1/(1+r) + D2/(1+r)^2.....

firm specific risk

most obvious risk

venture capital firms

pool funds from various sources, like individuals, pensions, insurance companies, large corps, university endowments

bullish vs bearish

positive vs negative

technical analysis

predicting future stock price movements on: -investor sentiment -errors in judgement -historical prices search for bullish and bearish signals

mental accounting

segment their money into mental "buckets" ex: spending regular income dif than bonus; house money

noise trader risk

sentiment-based risk noise trader: someone whose trades are not based on info or financially meaningful analysis

an economist announced findings that the recession is over and the economy is again entering expansion. assume market efficiency. can you profit from investing in the stock market after this announcement?

stock prices should immediately rise after this announcement, one cannot expect abnormal returns following it

index staleness

stocks that don't trade during time period

cognitive psychology

study of how people think, reason, and make decisions

fundamental analysis

studying a company's accounting statements and other financial and economic information to estimate the economic value of a company's stock -identify 'undervalued' stocks to buy and 'overvalued' stock to sell

leveraged buyout

take a company private -company buys all shares -cost is often high

behavioral finance

the area of research that attempts to understand and explain how reasoning errors influence investor decisions and market prices stems from *cognitive psychology*

a stock market analyst is able to identify mispriced stocks by comparing the average price for the last 10 days to the average price for the last 60 days. if this is true, what do you know about the market?

the market is not weak-form efficient

critically evaluate the following statement: "playing the stock market is like gambling. such speculative investing has no social value, other than the pleasure people get from this form of gambling."

unlike gambling, the stock market is a positive sum game; everybody can win. further, with respect to speculators, they provide liquidity to markets and thus help promote efficiency

private equity

used in the rapidly growing area of equity financing for nonpublic companies also includes large leveraged buyouts and the "middle market"

price ratio analysis

used to calculate estimates of expected future stock prices

residual income model (RIM)

value companies that don't pay dividends -assume pos earnings

initial public offering (IPO)

when a company offers stock for sale to the public for the first time

circuit breakers

when the market wide order flow is such that the exchange will cease for a short time

how can frame dependence lead to irrational investment decisions>

while it is human nature to use a narrow frame (gains & losses), doing so can lead to irrational decisions. using broad frames (wealth) results in better investment decisions

if a market is semistrong-form efficient, is it also weak-form efficient?

yes, since historical info is also public info; weak form is a subset of semi strong form