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Which of the following is NOT a type of derivative security?
Which of the following is NOT a type of derivative security?
Futures contracts trade on an open exchange.
Futures contracts trade on an open exchange.
True
What is the main objective of fundamental analysis in security analysis?
What is the main objective of fundamental analysis in security analysis?
To assess the intrinsic value of a stock.
A _____ is an agreement between two parties to exchange cash flows based on interest rate fluctuations.
A _____ is an agreement between two parties to exchange cash flows based on interest rate fluctuations.
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Match the following types of securities with their descriptions:
Match the following types of securities with their descriptions:
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Which type of derivative gives the right, but not the obligation, to buy or sell at a specific price?
Which type of derivative gives the right, but not the obligation, to buy or sell at a specific price?
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Hybrid securities can involve combining different technologies and strategies.
Hybrid securities can involve combining different technologies and strategies.
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What is the main use of forwards in financial trading?
What is the main use of forwards in financial trading?
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What is the purpose of evaluating intrinsic value?
What is the purpose of evaluating intrinsic value?
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Derivatives are primarily used today to ensure stable exchange rates for goods traded internationally.
Derivatives are primarily used today to ensure stable exchange rates for goods traded internationally.
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What does the cash flow statement summarize?
What does the cash flow statement summarize?
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The __________ activities section of the cash flow statement reflects cash flows related to the acquisition and disposal of long-term assets.
The __________ activities section of the cash flow statement reflects cash flows related to the acquisition and disposal of long-term assets.
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Which of the following is NOT one of the primary sections of a cash flow statement?
Which of the following is NOT one of the primary sections of a cash flow statement?
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Making comparative analysis is essential for investors to allocate resources effectively across different companies or industries.
Making comparative analysis is essential for investors to allocate resources effectively across different companies or industries.
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What does the income statement detail?
What does the income statement detail?
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Match each financial statement with its primary focus:
Match each financial statement with its primary focus:
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Which of the following best describes the purpose of profitability ratios?
Which of the following best describes the purpose of profitability ratios?
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What is a major limitation of fundamental analysis?
What is a major limitation of fundamental analysis?
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The solvency ratio assesses whether an entity has more debts than ownership.
The solvency ratio assesses whether an entity has more debts than ownership.
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Estimating cash flows accurately over long periods is easy due to stable market conditions.
Estimating cash flows accurately over long periods is easy due to stable market conditions.
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What does the interest coverage ratio indicate?
What does the interest coverage ratio indicate?
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What is the present value of the given project after calculating the cash flows?
What is the present value of the given project after calculating the cash flows?
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The formula for calculating assets is Assets = Liabilities + __________.
The formula for calculating assets is Assets = Liabilities + __________.
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Match the economic factors with their descriptions:
Match the economic factors with their descriptions:
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A company invests $150,000 and expects to generate cash inflows over five years. The total cash inflows discounted at 5% equals ______.
A company invests $150,000 and expects to generate cash inflows over five years. The total cash inflows discounted at 5% equals ______.
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Which of the following ratios uses EBIT to measure debt payment capability?
Which of the following ratios uses EBIT to measure debt payment capability?
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Match the following statements with their corresponding advantages or disadvantages:
Match the following statements with their corresponding advantages or disadvantages:
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Market prospect ratios are only used for analyzing the historical performance of stocks.
Market prospect ratios are only used for analyzing the historical performance of stocks.
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What role do fiscal policies play according to the information?
What role do fiscal policies play according to the information?
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What should an investor consider if a company's price to earnings ratio is lower than its competitors?
What should an investor consider if a company's price to earnings ratio is lower than its competitors?
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Diversifying your portfolio involves investing in a single asset class to maximize returns.
Diversifying your portfolio involves investing in a single asset class to maximize returns.
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What is the purpose of discounted cash flow analysis?
What is the purpose of discounted cash flow analysis?
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Investors should aim for _____ goals that align with their financial situation and timeline.
Investors should aim for _____ goals that align with their financial situation and timeline.
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Match the following concepts with their definitions:
Match the following concepts with their definitions:
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What factor does NOT typically impact stock performance?
What factor does NOT typically impact stock performance?
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Researching different investment options is unnecessary for making sound investment decisions.
Researching different investment options is unnecessary for making sound investment decisions.
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Name one economic change that can impact the value of specific securities.
Name one economic change that can impact the value of specific securities.
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Study Notes
Introduction to Security Analysis
- Security analysis assesses intrinsic value of a stock by looking at financial health and economic factors
- Intrinsic value is a fair value of a stock, it is the value that does not change overnight
- It guides investors in deciding if a stock is priced fairly, too low, or too high to help them decide whether to buy, keep, or sell it
Types of Securities
- Debt Securities: Represent loans made by investors to borrowers, with the promise of repayment of principal and interest
- Equity Securities: Represent ownership in companies, with the potential for dividends and capital appreciation
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Derivative Securities: Financial instruments that derive their value from an underlying asset, include futures, forwards, options, and swaps
- Futures: Agreement to buy or sell an asset at a future date
- Forwards: Futures contracts that don't trade on an open exchange; each contract is customized
- Options: Give the right, but not the obligation, to buy or sell a stock at a certain price by a certain date
- Swaps: Commonly used to hedge interest rates
Significance and Uses of Financial Statements
- Income Statement: Shows financial performance over a specific period, includes revenues, expenses, and net income; helps assess profitability and operational efficiency
- Balance Sheet: Shows a company's financial position at a specific point in time, includes assets, liabilities, and shareholder equity; provides insights into liquidity, solvency, and financial structure
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Cash Flow Statement: Summarizes cash and cash equivalents entering and leaving a company, divided into three main sections:
- Operating Activities: Cash transactions related to core business operations
- Investing Activities: Cash flows related to acquisition and disposal of long-term assets
- Financing Activities: Cash flows associated with funding the business
Key Financial Ratios
- Profitability Ratios: Measure how well an entity generates income relative to its revenues, operating costs, assets, and capital
- Solvency Ratios: Determine whether an entity has more ownership than debts, also called leverage ratios, involving comparisons of debt, assets, equity, and interest
- Efficiency Ratios: Measure how well an entity utilizes its assets and resources to generate income
- Interest Coverage Ratio: Debt and profitability ratio that shows how easily a company can pay interest on its outstanding debt, calculated by dividing earnings before interest and taxes (EBIT) by interest expense
- Market Prospect Ratios: Compare publicly traded companies' stock prices with other financial measures like earnings and dividend rates, used to analyze stock price trends and help figure out a stock's future market value
Key Economic Factors
-
Economic Analysis:
- Unemployment
- Inflation
- Interest Rates
- Consumer Confidence
-
Industry Analysis:
- Life Cycle
- Competition
- Supply Chain
- Technology
-
Government Impact on the Economy:
- Fiscal Policy: Spending and taxes affect economic growth
- Monetary Policy: Interest rates and inflation influence economic activity
- Regulations: Stabilize or constrain economic growth
-
Government Impact on Industries:
- Subsidies/Incentives: Support specific sectors
- Tariffs/Trade Policies: Protect domestic industries and impact import costs
- Stock Performance (Competitive Advantage): Highlights what makes a company stand out, like unique products or lower costs
- Competitive Pressures: Considers how competition affects pricing and profits
Investment Analysis
- Researching and evaluating a security or industry to predict its future performance and determine its suitability to a specific investor
- It involves creating an overall financial strategy
- Example: If an analyst wants to invest in Company A, they might look at its price to earnings ratio. If the price to earnings ratio is lower than other similar companies in the industry, the analyst might consider Company A's stock as undervalued, which could suggest it's a good investment opportunity.
Economic Changes Impacting Security Value
- Interest Rates
- Inflation
- Economic Growth
Suggestions for Better Investment Decisions
- Diversify Your Portfolio: Spread investments across different asset classes, industries, and geographies
- Do Your Research: Understand different investment options and how they align with your goals and risk tolerance
- Set Realistic Goals: Aim for achievable outcomes that align with your financial situation and timeline
- Mitigate Risks: Anticipate potential challenges and adjust portfolios accordingly
- Make Informed Decisions: Gain a deeper understanding of market forces to make better investment choices
Discounted Cash Flow (DCF)
- A method that estimates a company's stock value by predicting future earnings
- It calculates the present value of these earnings using a discount rate that reflects the company's risk
- Formula: Present Value = (Future Cash Flow / (1 + Discount Rate)^Number of Years)
- Advantages:
- Investment evaluation
- Applicable to a variety of projects
- Adjustable scenarios
- Disadvantages:
- Involves estimates
- Sensitive to assumptions and forecasts
- Unforeseen economic changes
- Estimating accurate cash flow over long periods can be challenging
Example of DCF Calculation
- A company needs $150,000 for a project that is expected to generate cash inflows for the next five years.
- It will generate $10,000 in the first two years, $15,000 in the third year, $25,000 in the fourth year, and $20,000 with a terminal value of $100,000 in the fifth year.
- Assuming the cost of capital is 5%, and no further investment is required during the term, the DCF of the project is calculated as follows:
- Year 1: $10,000 / (1 + 0.05)^1 = $9,523.81
- Year 2: $10,000 / (1 + 0.05)^2 = $9,070.29
- Year 3: $15,000 / (1 + 0.05)^3 = $12,957.56
- Year 4: $25,000 / (1 + 0.05)^4 = $20,567.56
- Year 5: ($20,000 + $100,000) / (1 + 0.05)^5 = $94,023.14
- Total Present Value = $146,142.36
- Initial Investment = $150,000
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Description
This quiz covers the fundamental concepts of security analysis, including the assessment of intrinsic value and the types of securities. Learn how to evaluate whether a stock is fairly priced and understand the significance of various security types like debt, equity, and derivatives. Test your knowledge on these essential financial principles.
