Long Position
A long position in an asset represents current or future ownership. A long position benefits when the asset increases in value.
Short Position
A short position represents an agreement to sell or deliver an asset or results from borrowing an asset and selling it. A short position benefits when the asset decreases in value.
Well-Functioning Security Markets
- Operational efficiency (lowest possible transactions costs).
- Informational efficiency (prices rapidly adjust to new information
Leverage Factor (Leverage ratio)
Leverage Factor = 1 / Margin Percentage
Leverage Return
Leverage Return = HPR X Leverage Ratio
Margin Call Price
Maintenance margin % = [(Initial Margin % x Pinitial + (Pmargin - Pinitial)] / Pmargin
Type of orders
- Execution instructions: how to trade; e.g., market orders, limit orders.
- Validity instructions: when to execute; e.g., stop orders, day orders, fill-or-kill orders.
- Clearing instructions: how to clear and settle; for sell orders, specify short sale or sale of owned security.
Bid-ask spread
- The bid price is the price at which a dealer will buy a security.
- The ask or offer price is the price at which a dealer will sell a security.
- The difference between the bid and ask prices is referred to as the bid-ask spread and is the source of a dealer’s compensation.
- The bid and ask are quoted for specific trade sizes (bid size and ask size).
- The quotation in the market is the highest dealer bid and lowest dealer ask from among all dealers in a particular security.
Price-weighted index
Price-weighted index = sum of stock prices / number of stocks in index
Number of stocks in index must be adjusted for stock splits
Most sensitive to stocks with the highest price
Market capitalization-weighted index
current index value = (Current total market value of index stocks / base year total market value of index stocks) × base year index value
Most sensitive to stocks with the highest market capitalization
Forms of EMH
- Weak form. Current stock prices fully reflect available security market info. Volume information/past price do not relate to future direction of security prices. Investor cannot achieve excess returns using tech analysis.
- Semi-strong form. Security prices instantly adjust to new public information. Investor cannot achieve excess returns using fundamental analysis.
- Strong form. Stock prices fully reflect all information from public and private sources. Assumes perfect markets in which all information is cost free and available to everyone at the same time. Even with inside info, investor cannot achieve excess returns.
Industry life cycle stages
- Embryonic: slow growth, high prices, large investment needed, high risk of failure.
- Growth: rapid growth, falling prices, limited competition, increasing profitability.
- Shakeout: slower growth, intense competition, declining profitability, cost cutting, weaker firms fail or merge.
- Mature: slow growth, consolidation, stable prices, high barriers to entry.
- Decline: negative growth, declining prices, consolidation.
Five Competitive Forces
- Rivalry among existing competitors
- Threat of entry
- Threat of substitutes
- Power of buyers
- Power of suppliers
Behavioral Finance
Disposition effect: behavioral bias in which investors tend to avoid realizing losses but, rather, seek to realize gains.
Conservatism: behavior of reacting slow to changes.
Loss aversion: Over-reacting, including a dislike for losses more than liking comparable gains.
Representativeness: A behavioral bias in which an investor assesses probabilities of outcomes depending on how similar they are to the current state is called
Narrow framing: Investors focus on issues in isolation .
Trailing P/E ratio
Trailing P/E ration = Current stock price / Current earnings per share
P/E ratio based on the Gordon growth dividend discount model
= (D1 / E1) / (r − g)
Declaration date, ex-dividend date, record date, and payment date
- Declaration date. The date the board of directors approves payment of a dividend, specifying the per-share dividend amount, the date shareholders must own the stock to receive the dividend (record date), and the date the dividend payment will be made (payment date). Only occurs on business days. Determined by Corporation.
- Ex-dividend date. The first day on which a share purchaser will not receive the next dividend. The ex-dividend date is one or two business days before the holder-of-record date, depending on the settlement period for stock purchases. If you buy the share on or after the ex-dividend date, you will not receive the dividend. Only occurs on business days. Normally determined by the security exchange on which the shares are listed
- Holder-of-record date (record date). The date on which all owners of shares will receive the dividend payment on their shares. Only occurs on business days. Determined by Corporation.
- Payment date. The date dividend checks are mailed to, or payment is made electronically to, holders of record. Can occur on weekend or holiday.
Cost of equity
A company’s cost of equity is often used as a proxy for the investor’s minimum required rate of return because it is the minimum expected rate of return that a company must offer its investors to purchase its shares in the primary market and to maintain its share price in the secondary market.
Momentum Tilt and Value Tilt
- Momentum Tilt: Weight increase with stock price
- Value Tilt: Weight increase with earning yield
Stop Order vs. Limit Order
- Stop Order: Minimize loss, validity instruction may be executed at a less preferable price if the next available price is much lower or much higher than the stop order
- Limit Order: Maximize gain, execution instruction, may not be filled
Market Anomaly
An anomaly is something that deviates from the common rule. Tests of the EMH are frequently called anomaly studies, so in the efficient markets literature, a market anomaly is something that would lead us to reject the hypothesis of market efficiency.
Contingent convertible bonds
Contingent convertible bonds automatically convert to equity if the issuer’s equity falls below the minimum percentage stipulated by regulators. Issuers are typically banks. Neither the issuer nor the bondholder has an option to convert the shares.
Medium-term notes (MTNs)
- Custom debt instruments offered continuously through agents
- Buyer specifies desired face value & maturity
- Maybe any maturity, not necessarily medium term
- Less liquid than publicly traded bonds from same issuer
Macaulay duration
- The time horizon at which reinvestment risk and market price risk offset each other.
- Holding period < Macaulay: Price decrease has more effect
- Holding period > Macaulay: Reinvestment has more effect
