Final Study Guide Good Luck everyone If you have any questions email me Table of Contents Test 3 4 Chapter 3 4 Types of Brokerage Firms 5 Investing Tips 5 Basic Order Types 5 Market Order 5 Advantages 5 Disadvantage 5 Limit Order 5 Limit Order Process 6 Order of Precedence 6 Advantage 6 Disadvantage 6 Stop Order 6 Advantage 6 Disadvantage 6 Miscellaneous 7 Chapter 4 7 Return 7 Why Return is Important 7 Factors in Return 8 Time Value of Money Just the concept on test 8 Risk and Diversification 10 Critical Thinking Questions 10 Return 11 Return Components 11 Risk Premium 12 Holding Period Return 12 Using HPRs 13 Yield Internal Rate of Return IRR 13 Using IRR 14 Interest on Interest 14 Sources of Risk 14 Chapter 6 Common Stocks 15 The Appeal 15 Bear Markets 15 Common Stocks 16 Advantages 16 Disadvantages 16 Issuing Stock 17 Why do a stock split 17 Stock Split Math 17 Treasury Stocks 17 Classified Common Stock 18 Common Stock Valuation 18 Dividends 18 Chart Breakdown 19 Stock prices during a dividend 19 More on Dividends 20 Foreign Stocks 20 Global Investing 20 Risky Stocks 21 Mutual Funds 21 What is a Mutual Fund MF 21 How it works 21 MF and Taxes 21 MF Return Sources 22 Mutual Fund Attractions 22 Mutual Fund Drawbacks 22 Open End Mutual Fund 22 Other Characteristics 22 Close Ended MF 23 Characteristics 23 Exchange Traded Funds 23 Load Fund vs No Load Funds 23 Fees and Etc 24 Questions 24 Hedge Funds 24 Investment strategies 24 Differences Hedge vs Mutual 25 Managers very very rarely beat the market 25 AREAS NOT COVERED ON THE EXAM 25 Test 3 Chapter 3 Stockbrokers are licensed by Facilitate transactions of security buyers and sellers Facilitators Execute trades o Buy or sell your stocks Retain securities in street name Research advice Account statements Money market investment of idle cash Churning o Mainly electronic Enables faster trades If you or your broker held the piece of paper that is your stock it would be a hassle to trade and it could be damaged Types of Brokerage Firms Full Service Premium Discount Online Lowest commissions It begs the question What s in their best interest Investing Tips Not everything online is true Double check tickers and transactions for accuracy AAPL and APL are very different Studies show the more you trade The less likely you ll beat the market You are too slow to realize losses Too quick to realize gains People trade on emotions It is difficult to interpret data Basic Order Types Market order Limit Order Stop order Trade off Advantages It is Certain Speed Disadvantage Price Certainty vs Execution Certainty Market Order Tells broker to immediately buy sell Most Used Regardless of price the order is placed now Price uncertainty Risk in very fast markets the price you sell at is uncertain Limit Order Limit order to buy you set the maximum purchase price Tell broker to buy only if less than or equal to limit price Don t pay more than XX xx OR Limit order to sell you set the minimum sell price Tell broker to sell only if above or equal to a certain price Get best price in trading range Limit Order Process Order Entered into specialist s dealers book Executed at limit price or better o After orders with higher precedence happen first Happens after market order Order of Precedence 1 Market order 2 Limit Order to buy Higher price buys first 3 Limit Order to Sell Low prices sell first 4 Same Price orders Execute in chronological order Advantage Price Certainty Disadvantage Can miss the market Didn t make as much money as you could have o Lost potential earnings Stop Order Suspended order Activated if specified price is reached Becomes a market order Stop order to sell Exits long position Advantage Execution certainty if activated Disadvantage Uncertain price until executed Could lose on potential profits if it spikes down Main use Stop losses on profit if market moves against you Example Buy at 20 Market moves to 30 Set stop at 28 incase stock prices drop and you retain 8 profit Not used unless stock drops to specified value Miscellaneous Order time limits Market orders not applicable Limit or Stop orders o Fill or Kill sell entire order or sell nothing and order is cancelled o Day order Only good for that trading day o GTC Good Till Cancel 30 days or 60 days Securities Investor Protection Corporation SIPC Insures accounts against brokerage firm failures Chapter 4 Return The level of profit reward for investing Return Components Current income cash received as a result of owning an investment Capital gains losses the difference the selling price and the purchase Total Return current income capital gain or loss of an investment over price of an investment a specified period of time Why Return is Important Lets you compare the return you expect or receive with the return you require What is your required return Depends on investment costs on the level of risk you re willing to take Historical Performance Provides a basis for future expectations Does not guarantee future performance Expected Return What you think an investment will earn in the future Determines what you ll pay for an investment or if you ll make the investment at all Factors in Return Internal Forces Forces inside the company Investment type Risks associated with a specific investment External Forces risks facing all investments although to varying degrees Political environment New laws regulation Business environment Changes from the fed economy Economic environment Rescission changes in investors expectations Inflation Deflation Average Annual Return Asset Class Germany U S U K Stocks 11 2 11 2 13 2 Treasury Bonds 5 5 6 0 Time Value of Money Just the concept on test 4 9 Today s dollar is worth more than a future dollar Treasury Bills 4 0 5 1 4 5 o Spend it o Invest o Avoid inflation Reasons Inflation 3 1 4 2 5 6 FV amount money grows to Source Elroy Dimson Paul Marsh and Mike Staunton if compounded over a Triumph of the Optimists 101 Years of Global Investment Returns predetermined time and interest rate How much will 100 be worth what is its future value FV in 5 years if it earns a 9 interest rate that compounds annually Answer 100 1 09 5 153 86 The more frequently money You should be indifferent compounds the more between interest it earns or the more interest you pay Receiving 100 today that you can invest at a that you can invest at a 9 interest rate compounded annually Receiving 153 86 five years from now Correctly Risk and Diversification Principal of Diversification multiple
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