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Equities Flashcards

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1
Q

What does Section II.B. of the CIMA exam focus on?

A

Equity: types, valuation methods, indices, international diversification, and correlation trends.

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2
Q

Name three resources recommended for Section II.B.

A

Investment Planning Answer Book (Jay Shein), Investment Advisor Body of Knowledge (Dobbs), Investments (Bodie, Kane, Marcus).

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3
Q

What are the two main types of stocks?

A

Common stocks and preferred stocks.

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4
Q

What rights do common stockholders typically have?

A

Voting rights, dividends, and potential for capital appreciation.

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5
Q

What risks are associated with common stock?

A

Market risk, no guaranteed dividends, and company-specific risk.

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6
Q

What are key features of preferred stock?

A

Priority in dividends and liquidation, limited voting rights, and generally fixed par value.

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7
Q

What is cumulative preferred stock?

A

Missed dividends must be paid before any common stock dividends.

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8
Q

What is convertible preferred stock?

A

Can be converted into a specified number of common shares.

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9
Q

What is an ADR?

A

American Depository Receipt, allowing U.S. investors to invest in foreign stocks via U.S. exchanges.

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10
Q

How does intrinsic valuation work?

A

Discounts future cash flows to present value to assess inherent value.

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11
Q

What is DCF?

A

Discounted Cash Flow � estimates intrinsic value based on forecasted cash flows and discount rate.

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12
Q

What is the formula for terminal value in DCF?

A

Terminal Value = FCF � (1 + g) / (r - g)

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13
Q

What is the Dividend Discount Model (DDM)?

A

Values a stock by discounting future dividends to present value.

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14
Q

What is the DDM formula?

A

Value = Dividend / (Discount Rate - Growth Rate)

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15
Q

What is the CAPE ratio?

A

Cyclically adjusted PE ratio using 10-year average inflation-adjusted EPS.

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16
Q

How is CAPE calculated?

A

Share price / 10-year average inflation-adjusted earnings.

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17
Q

What does a high CAPE ratio indicate?

A

Potential overvaluation.

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18
Q

What does PEG ratio stand for?

A

Price/Earnings to Growth ratio.

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19
Q

What does a PEG ratio < 1 suggest?

A

Stock may be undervalued.

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20
Q

How is growth rate calculated using retention ratio?

A

Growth = ROE � (1 - Dividend / Earnings)

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21
Q

What does the price-to-book (P/B) ratio measure?

A

Market value relative to book value.

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22
Q

What does a P/B ratio < 1 indicate?

A

Stock may be undervalued.

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23
Q

What does Tobin�s Q Ratio measure?

A

Market value / replacement cost of assets.

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24
Q

What does a Q-ratio < 1 suggest?

A

Assets are undervalued.

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25
What is the formula for ROE?
Net income / Shareholder's equity.
26
What is ROA?
Return on Assets = EBIT / Total assets.
27
What does the price-to-sales ratio evaluate?
Stock price relative to revenue per share.
28
What is a residual income model?
Valuation = Net income - equity charge (cost of capital � equity).
29
What is the formula for Free Cash Flow?
EBIT(1 - tax rate) + Depreciation - CAPEX - change in working capital.
30
What is WACC?
Weighted Average Cost of Capital: cost of capital weighted by proportion.
31
What is the best valuation metric for startups with no earnings?
Price-to-sales ratio.
32
What is a price-weighted index?
Index weighted by stock price (e.g., DJIA).
33
What is a cap-weighted index?
Index weighted by market capitalization (e.g., S&P 500).
34
What is an equal-weighted index?
Each stock contributes equally to index performance.
35
What is a fundamentally-weighted index?
Weights based on fundamentals like earnings or book value.
36
What are benefits of international diversification?
Reduced risk, new growth opportunities, and reduced correlation.
37
What risks come with international investing?
Currency risk, political risk, tax issues, and limited transparency.
38
What are characteristics of developed markets?
High income, stable regulations, and efficient financial markets.
39
What are characteristics of emerging markets?
High growth potential, developing infrastructure, higher volatility.
40
What are frontier markets?
Early-stage markets with high growth potential and high risk.
41
What is the impact of globalization on market correlations?
It has increased correlations among developed markets.
42
What is a limitation of P/B ratio?
May not reflect value for firms with many intangible assets.
43
What are examples of cap-weighted indexes?
S&P 500, Euro Stoxx 50, MSCI EAFE.
44
What does ROE indicate to shareholders?
Company�s ability to generate profit from equity.
45
How does equal weighting reduce index bias?
Prevents overrepresentation of large-cap stocks.
46
Why might a fundamental index outperform?
Focuses on undervalued companies based on fundamentals.
47
What are liquidity ratios?
Current ratio and quick ratio measure short-term financial health.
48
How is the quick ratio calculated?
(Cash + Equivalents + Short-term investments + Receivables) / Current liabilities.
49
How is the current ratio calculated?
Current assets / Current liabilities.
50
What does a PEG > 2 suggest?
The stock may be overvalued.
51
What does a high P/E ratio imply?
Investors expect strong future growth.
52
What is EPS?
Earnings per share: net earnings / outstanding shares.
53
What causes a high Q-ratio?
Market value exceeds replacement cost of assets.
54
What is the formula for ROA using margin and turnover?
ROA = Margin � Turnover.
55
What is margin in the context of ROA?
Operating earnings / revenue.
56
What is turnover in the context of ROA?
Revenue / assets.
57
Why compare a company�s growth to its industry?
To assess competitive positioning.
58
What does book-to-market ratio represent?
Book value / market value.
59
What causes differences in developed vs. emerging market P/E ratios?
Developed markets usually have higher valuations.
60
What is a challenge of investing in frontier markets?
Limited transparency and illiquidity.
61
What is the current CAPE for Bulldog Inc. if price is $112 and inflation-adjusted EPS is $3.40?
CAPE = 33.
62
Why is diversification effective?
It reduces unsystematic risk by combining uncorrelated assets.
63
What drives sector correlation changes?
Macroeconomic trends, global events, and financial integration.
64
What is the relationship between emerging markets and volatility?
Emerging markets typically exhibit higher volatility.
65
What is dividend payout ratio?
Dividend / earnings.
66
What does the retention ratio represent?
The percentage of earnings retained for reinvestment.
67
What are the 3 main equity valuation categories?
Intrinsic, relative, and liquidation models.
68
Why is discounted cash flow preferred for long-term investors?
Focuses on fundamentals and future growth.
69
How does the DDM differ from DCF?
DDM focuses solely on dividends, while DCF includes all cash flows.
70
What is a key limitation of relative valuation?
Assumes similar firms deserve similar valuation.
71
Why are cap-weighted indexes dominant?
They reflect market size and are easy to track.
72
How do frontier markets compare to developed?
Higher risk and growth potential but low liquidity and transparency.
73
Why is CAPE considered more reliable than current PE?
It smooths out earnings fluctuations over time.
74
What limits the accuracy of CAPE?
Structural shifts and external events not captured in earnings.
75
What is one reason for rising global equity correlations?
Technological globalization and capital flows.

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