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Questions and Answers
What is a bond, and how does it function as an investment for the lender?
What is a bond, and how does it function as an investment for the lender?
A bond is a loan made by an investor to a borrower, typically a company, that is repaid with interest over time.
Explain the concept of diversification in an investment portfolio.
Explain the concept of diversification in an investment portfolio.
Diversification is a risk management strategy that mixes various investment assets within a portfolio to reduce risk.
What distinguishes stock trading from investing?
What distinguishes stock trading from investing?
Stock trading focuses on buying and selling shares for short-term profits, while investing involves holding assets for long-term gains.
Define ETFs and how they differ from mutual funds.
Define ETFs and how they differ from mutual funds.
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What does the Semi-Strong-Form Efficient Market Hypothesis assert about publicly available information?
What does the Semi-Strong-Form Efficient Market Hypothesis assert about publicly available information?
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What is the primary advantage of mutual funds for small investors?
What is the primary advantage of mutual funds for small investors?
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Explain the difference between the arithmetic average and the geometric average in terms of investment returns.
Explain the difference between the arithmetic average and the geometric average in terms of investment returns.
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How do stock prices react to news about future profits?
How do stock prices react to news about future profits?
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What expectation do we have about the efficiency of financial markets?
What expectation do we have about the efficiency of financial markets?
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What can investors potentially gain from equity market inefficiencies?
What can investors potentially gain from equity market inefficiencies?
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Study Notes
Securities Issuance Process
- A firm issuing securities interacts with underwriters and the public.
- A lead underwriter manages the process.
- An underwriting syndicate comprises investment banks (e.g., Banker A, Banker B, Banker C, Banker D).
- Private investors purchase securities.
Definitions
- Bonds: A loan to a company, repaid with interest.
- Stocks: Ownership in a company, increasing in value with the company's success.
- Mutual funds: Shared investment access to diversified portfolios, potentially with fees.
- Portfolios: Diversified asset collections to mitigate risk.
Efficient Market Hypothesis
- The semi-strong form asserts that all publicly available information is reflected in security prices (e.g., financial statements, analysts' estimates, economic news).
Portfolios and Diversification
- Portfolios are collections of assets, important for long-term goals like retirement.
- Diversification is a risk management tool that combines many different investments.
- Diversification and portfolio management go hand-in-hand.
- Investment: buying assets for long-term gains.
- Trading: buying and selling assets frequently for short-term profit.
Exchange-Traded Funds (ETFs)
- ETFs are alternatives to mutual funds, providing more flexibility.
- They trade on exchanges throughout the business day.
- They typically have a lower expense ratio than mutual funds.
- Financial markets are not expected to be perfectly efficient.
Mutual Funds Advantages and Disadvantages
- Advantages: Access to professional investment help and diversified portfolios.
- Disadvantages: Potential fees that reduce profit.
Return Calculation
- Arithmetic average: The average of yearly returns.
- Geometric average: The growth rate of an investment over time.
Stock Price Determinants
- Stock prices generally rise with good future profit news and fall with bad news.
- Historically, some evidence suggests inefficiencies in financial markets.
Market Efficiency
- Financial markets are generally assumed to be at least semi-strong form efficient.
- Market prices reflect public information relatively accurately.
- Hedge funds have addressed market inefficiencies by trading aggressively.
Anomalies to the Efficient Market Hypothesis
- Value Stocks: Stocks with tangible assets and current earnings outperform growth stocks.
- Momentum Stocks: Stocks performing well in the last six to twelve months tend to continue outperforming.
- Corporate Announcements: Market under-reacts to corporate news; post-earnings returns continue to be positive.
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Description
This quiz covers the fundamentals of the securities issuance process, including the roles of underwriters and private investors. It also defines key financial instruments such as bonds, stocks, and mutual funds. Additionally, the Efficient Market Hypothesis and the importance of diversification in portfolios are discussed.