Investments Chap2,3,5,12 Study Notes PDF

**[CHAPTER 2]** 1. What is the difference between the primary market and the secondary market? What are three choices to market securities in the primary market? The **primary market** is where firms and governments sell new issues of securities directly to investors, allowing the issuer...

**[CHAPTER 2]** 1. What is the difference between the primary market and the secondary market? What are three choices to market securities in the primary market? The **primary market** is where firms and governments sell new issues of securities directly to investors, allowing the issuer to receive the proceeds from these sales. In contrast, the **secondary market** is where securities trade after they have been issued, and transactions do not involve the issuer. In the secondary market, money flows between investors rather than from investors to the issuer. Three choices for marketing securities in the primary market include: - **Public offering**: Offering securities to the general public. - **Rights offering**: Offering shares to existing stockholders on a pro-rata basis. - **Private placement**: Selling securities directly to select private investors without SEC registration 12. 2. What are underwriting, prospectus, quiet period, red herring, and road show in the IPO process? **Underwriting** involves an investment bank purchasing securities from the issuer and reselling them to the public, assuming the risk of the sale. A **prospectus** is a disclosure document that outlines key aspects of the securities and the issuer\'s financial position. The **quiet period** is a time during which the issuer cannot communicate with investors while waiting for SEC approval. A **red herring** is a preliminary prospectus that indicates the offer\'s tentative nature. A **road show** is a series of presentations made by the issuer to potential investors to gauge interest and explain the business 34. 3. What are benefits and disadvantages of direct listing? The benefits of a **direct listing** include saving on investment banking fees and allowing pre-IPO investors to liquidate holdings. However, disadvantages include the lack of a road show to promote the company and uncertainty regarding the initial trading price. Additionally, direct listings do not raise new capital, making them less suitable for companies needing funds 56. 4. What is difference between a broker and a dealer? What do market makers do in dealer markets? What is bid/ask spread? A **broker** facilitates transactions between buyers and sellers, while a **dealer** buys and sells securities for their own account. Market makers in dealer markets provide liquidity by offering to buy and sell securities at stated prices. The **bid/ask spread** is the difference between the bid price (the price a buyer is willing to pay) and the ask price (the price a seller is willing to accept), representing a trading cost for investors 78. 5. What is over the counter (OTC) market? What is the characteristic of companies traded on the OTC markets? The **over-the-counter (OTC) market** consists of securities that trade outside of formal exchanges, primarily involving smaller companies that do not meet listing requirements. Companies traded on OTC markets often provide little information about their operations, and the market is divided into tiers based on the level of disclosure and regulation 910. 6. What are conditions in security markets normally associated with the bull market? What are conditions in security markets normally associated with the bear market? Conditions in **bull markets** are characterized by rising prices, investor optimism, and economic recovery, often supported by government stimulus. Conversely, **bear markets** are associated with falling prices, investor pessimism, and economic slowdown, typically marked by a decline of at least 20% in stock prices 11. 7. What is diversification? What is international investment? Why international investment relates to diversification? **Diversification** involves including a variety of different securities in a portfolio to increase returns and reduce risk. **International investment** refers to investing in foreign markets, which enhances diversification by spreading risk across different economies and currencies. However, investing internationally carries specific risks, such as changes in trade policies, labor laws, and political instability in foreign countries 1213. **Diversification** is the strategy of including a variety of different securities in a portfolio to increase returns and reduce risk. This can be achieved by holding a wider range of industries and securities, securities traded in various markets, and securities denominated in different currencies. The potential for diversification is even greater when combining domestic and foreign securities, especially for investors from less diversified home markets 12. **International investment** refers to investing in foreign markets, which allows investors to seek opportunities beyond their home countries. This can be done either directly, by purchasing foreign securities, or indirectly, by investing in multinational corporations that operate globally. Many U.S.-based firms, such as Google and Coca-Cola, derive a significant portion of their revenues from overseas, providing a way for investors to achieve international diversification 14. **International investment** relates to diversification because it enables investors to spread their risk across different economies and currencies. By investing in a mix of domestic and foreign securities, investors can potentially enhance their portfolio\'s performance and reduce exposure to any single market\'s volatility 12. 8. What specific risks may involve when investing in foreign markets? Investing in foreign markets comes with specific risks, including: 1. **Currency exchange risk**: Fluctuations in currency values can significantly impact returns on foreign investments. For example, changes in the currency exchange rate can affect the value of profits or losses when converting back to the investor\'s home currency 15. 2. **Political and economic instability**: Changes in trade policies, labor laws, and taxation can affect the operating conditions for firms in foreign countries. Additionally, the stability of the government in those countries can pose risks 13. 3. **Regulatory differences**: Investors may encounter different securities exchange rules, transaction procedures, and accounting standards in foreign markets, which can complicate investment decisions 16. 9. What is margin in margin trading? What is margin requirement? What is initial margin? What is maintenance margin? What is a margin call? Margin trading involves borrowing funds from a broker to purchase securities, allowing investors to leverage their investments. The **margin** in margin trading refers to the amount of equity an investor must maintain in their margin account, which acts as collateral for the borrowed funds 14. The **margin requirement** is the minimum amount of equity that must be maintained in a margin account. This requirement is set by the Federal Reserve Board and can vary by brokerage firms, which may impose stricter requirements 15. **Initial margin** is the minimum amount of equity that an investor must provide at the time of purchase when executing a margin transaction. This requirement serves as a limit on how much risk an investor can take through margin trading 15. **Maintenance margin** is the absolute minimum amount of equity that must be maintained in the margin account at all times. If the equity falls below this level, the investor will receive a **margin call**, which is a demand from the broker to deposit additional funds or sell securities to bring the account back up to the required level 16. 10. What is the difference between a long purchase (long position) and a short selling (short position)? The difference between a **long purchase (long position)** and **short selling (short position)** lies in the investor\'s expectations about the price movement of the security: - In a **long position**, an investor buys securities expecting their prices to rise, allowing them to sell at a profit later. - In a **short position**, an investor borrows securities to sell them at the current market price, anticipating that the price will fall so they can buy them back at a lower price, returning the borrowed shares and pocketing the difference. 1. What are \"Investment tools\" we can use when we do investment research?\ What is screening? **Investment Tools and Screening** Investment tools for research include various resources that help analyze and evaluate potential investments. Screening refers to the process of filtering stocks or securities based on specific criteria, such as price, market capitalization, or financial ratios, to identify suitable investment opportunities. 1 2\. What are popular financial journals and business periodicals in the market? **Financial Journals and Business Periodicals** Popular financial journals and business periodicals include sources like *The Wall Street Journal*, *Financial Times*, and *Bloomberg*. These publications provide insights into market trends, economic news, and investment strategies. 1 3\. What is Regulation FD? What is Form 10-K? Which web site maintained by SEC providing free access to Form 10-K? **Regulation FD and Form 10-K** Regulation FD (Fair Disclosure) mandates that publicly traded companies disclose material information to all investors simultaneously, ensuring transparency. Form 10-K is an annual report filed with the SEC by publicly traded companies, providing a comprehensive overview of their financial performance. The SEC\'s website, *Freeedgar.com*, offers free access to these filings. 2 4\. Which popular investment website provides information for bond education, research report, and historical data? Which website allows investors to but Treasury securities online through Treasury Direct program? **Investment Websites** Popular investment websites for bond education and research include *Morningstar* and *Yahoo Finance*. The Treasury Direct program allows investors to buy Treasury securities online, providing a secure platform for government bonds. 1 5\. What is the difference between odd lot and round lot? **Odd Lot vs. Round Lot** An odd lot consists of fewer than 100 shares, while a round lot is a standard unit of 100 shares. For example, purchasing 25 shares is an odd lot, while buying 200 shares is a round lot. 3 6\. What are differences among market order, limit order, and stop-loss order?\ What are day order and good-\' til-canceled (GTC) order? **Market Order, Limit Order, and Stop-Loss Order** - **Market Order**: Executes immediately at the current market price. - **Limit Order**: Sets a specific price to buy or sell; executed only if that price is met. - **Stop-Loss Order**: Triggers a sale when the stock price drops to a specified level, protecting against losses. Day orders expire at the end of the trading day, while Good-\'Til-Canceled (GTC) orders remain active until executed or canceled. 45 7\. What is the difference between averages and indexes? What are popular stock market averages and indexes? How many companies are included in DJA, S&P 500 Index, and Nasdaq Composite Index? Which index is frequently used for estimating \"market return\"? **Averages vs. Indexes** Averages are statistical measures that summarize a set of data, while indexes track the performance of a group of stocks. Popular stock market averages include the DJIA and S&P 500 Index, which consist of 30 and 500 companies, respectively. The Nasdaq Composite Index includes over 3,000 stocks. The S&P 500 is frequently used for estimating \"market return.\" 67 8\. What is a day trader? What are disadvantages of day trading? **Day Trader and Disadvantages of Day Trading** A day trader buys and sells securities within the same trading day, aiming to profit from short-term price movements. Disadvantages include high risk due to market volatility and the potential for significant losses, especially when trading on margin. 8 9\. What is Securities Investor Protection Corporation (SIPC)? What is the difference between mediation and arbitration? **Securities Investor Protection Corporation (SIPC)** The SIPC protects investors against the loss of cash and securities held by a broker in the event of a firm\'s bankruptcy. Mediation is an informal dispute resolution process, while arbitration is a formal, binding process requiring both parties to accept the panel\'s decision. 91 10\. What are investment advisors and investment clubs? What are advantages of investment clubs? **Investment Advisors and Investment Clubs** Investment advisors provide professional guidance on investment strategies, while investment clubs are groups of individuals pooling resources to invest collectively. Advantages of investment clubs include shared knowledge, reduced risk, and lower costs through collective buying power.  **[CHAPTER 5]** 1. **What is a portfolio? What is a growth-oriented portfolio? What is an income-oriented portfolio? What is an efficient portfolio?** A portfolio is a collection of investments assembled to meet one or more investment goals. A growth-oriented portfolio focuses on long-term price appreciation, while an income-oriented portfolio is designed to generate regular dividends and interest payments. An efficient portfolio provides the highest return for a given level of risk, balancing the trade-offs between risk and return effectively 1. 2. **A portfolio\'s return depends on two things (factors). What are these two factors? A portfolio\'s standard deviation depends on three things (factors). What are these three factors?** A portfolio\'s return depends on the expected returns of the individual assets and the weights of those assets in the portfolio. The standard deviation of a portfolio depends on the variances of the individual assets and the correlations between them 2. 3. **What is correlation? What is positively correlated? What is negatively correlated? What is uncorrelated? What is correlation coefficient? What is perfectly positively correlated? What is perfectly negatively correlated? How correlation affects portfolio risk?** Correlation is a statistical measure of the relationship between two series of numbers. If two series tend to move in the same direction, they are positively correlated; if they move in opposite directions, they are negatively correlated. A correlation coefficient ranges from +1.0 (perfectly positively correlated) to -1.0 (perfectly negatively correlated). Uncorrelated assets have a correlation coefficient around 0. Lower correlation between assets in a portfolio generally leads to greater risk reduction through diversification 34. 4. **What are effectiveness, methods, and costs of international diversification?** International diversification offers greater diversification than domestic investments because returns in different markets do not move in sync. Methods include investing in international mutual funds or American Depositary Receipts (ADRs). While investing in foreign securities can be more costly, these methods provide diversified foreign investments at relatively low costs 5. 5. **What is diversifiable (unsystematic) risk? What is undiversifiable (systematic) risk? What is total risk of a portfolio and how is it measured? What is beta and what does beta measure?** Diversifiable risk, or unsystematic risk, is the portion of risk that can be eliminated through diversification. Undiversifiable risk, or systematic risk, is the risk that remains regardless of diversification. Total risk is the sum of diversifiable and undiversifiable risk. Beta measures a security\'s sensitivity to market movements, indicating its undiversifiable risk 67. 6. **How to interpret beta for a stock from its association with the market movement and risk?** Beta indicates how a stock\'s return responds to market movements. A beta greater than 1.0 means the stock is more volatile than the market, while a beta less than 1.0 indicates it is less volatile. For example, a stock with a beta of 1.5 would be expected to increase by 15% if the market rises by 10% 8. 7. **What is CAPM? What is Security Market Line (SML)?** The Capital Asset Pricing Model (CAPM) links expected return to risk, stating that an asset\'s expected return equals the risk-free rate plus a risk premium based on its undiversifiable risk (beta). The Security Market Line (SML) graphically represents the expected return for any security given its beta, illustrating that higher risk corresponds to higher expected returns 9. 8. **What is efficient frontier? What is the optimal portfolio?** The efficient frontier is a graphical representation of the set of optimal portfolios that offer the highest expected return for a given level of risk. The optimal portfolio is located on this frontier, maximizing returns while minimizing risk 10. 9. **What is portfolio beta? How to interpret portfolio beta?** Portfolio beta is the weighted average of the betas of the individual assets in the portfolio. A portfolio beta of 1.0 indicates that the portfolio\'s returns will move with the market. A beta greater than 1.0 suggests higher volatility compared to the market, while a beta less than 1.0 indicates lower volatility 11. 10. **What is the difference between traditional portfolio management and modern portfolio management?** Traditional portfolio management emphasizes a wide variety of stocks and bonds, focusing on interindustry diversification. In contrast, modern portfolio management (MPT) relies on quantitative analysis to optimize portfolios, emphasizing the reduction of correlations between securities to minimize risk 12 **[CHAPTER 12]** 1. **What is a mutual fund? What is an ETF? What is a hedge fund? What is the difference among a mutual fund, an ETF, and a hedge fund?** A **mutual fund** is a pooled investment vehicle that combines money from multiple investors to invest in a diversified portfolio of securities, making it accessible to investors of all levels. This concept is based on *pooled diversification*, which allows investors to hold a well-diversified portfolio even with small amounts of capital 1. An **Exchange-Traded Fund (ETF)** is similar to a mutual fund but trades on stock exchanges like a stock. ETFs combine characteristics of both open-end funds and closed-end funds, allowing for intraday trading and often lower costs due to passive management 2. A **hedge fund** is also a pooled investment vehicle but typically employs more complex strategies, including long and short positions and derivatives, to achieve high returns while managing risk 3. The main differences are: - **Structure**: Mutual funds and ETFs are generally more accessible to everyday investors, while hedge funds often require higher minimum investments and are less regulated. - **Management Style**: Mutual funds can be actively or passively managed, while hedge funds often use complex strategies to maximize returns 3. 2. **What is pooled diversification? What is the difference between an actively managed fund and a passively managed fund?** **Pooled diversification** refers to the strategy of combining funds from multiple investors to create a diversified portfolio, which reduces risk by spreading investments across various securities 1. An **actively managed fund** involves a fund manager making investment decisions to outperform a benchmark index, while a **passively managed fund** aims to replicate the performance of a specific index, typically resulting in lower fees and expenses 2. 3. **What are advantages (attractions) and disadvantages (drawbacks) of investing (owning) mutual funds?** **Advantages** of mutual funds include: - **Diversification**: Access to a broad range of securities 1. - **Professional Management**: Investors benefit from the expertise of fund managers. **Disadvantages** include: - **Fees**: Management fees can reduce overall returns. - **Lack of Control**: Investors have no say in individual investment decisions 1. 4. **What is the difference between an open-end fund and a closed-end fund? How is the market price of an open-end fund determined? How is the market price of a closed-end fund determined?** An **open-end fund** continuously issues and redeems shares based on investor demand, with its price determined by the net asset value (NAV) at the end of each trading day 2. In contrast, a **closed-end fund** has a fixed number of shares that trade on exchanges, and its market price can fluctuate based on supply and demand, often deviating from its NAV 2. 5. **What is a Real Estate Investment Trust (REIT)?** A **Real Estate Investment Trust (REIT)** is a company that owns, operates, or finances income-producing real estate. REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership without having to buy, manage, or finance any properties themselves. They typically pay out dividends to investors, making them an attractive option for income-seeking investors.