Nature of Finance & Market efficiency (1&2)

Question 1

Explain the relationship between equities/shares and a firms management?

Answer 1

Equities/shares are owned by stockholders
Stockholders elect directors
Directors elect management

Question 2

When are dividends paid and where from?

Answer 2

Dividends are paid quarterly, semi-annually or annually
Dividends are paid from Net profit after Tax

Question 3

What is enterprise value (EV) and its equation?

Answer 3

EV = value of bonds +value of shares
EV is a measure of the company’s value

Question 4

Are bonds and shares equity or debt?

Answer 4

Bonds are debt
Shares are equity

Question 5

What are the main parts of the role of a Financial Manager?

Answer 5

Investment Decisions
Financing decisions
Financial Planning
Oversee accounting and audit in firm
Ensure Financial welfare

Question 6

What is the investment decision?

Answer 6

Deciding how to allocate resources
Capital budgeting (decisions for long-term investments)
Analysing risk of investments

Question 7

What is the financing decision?

Answer 7

Choosing capital structure ( mix of debt and equity)
Choosing between issuing shares, taking loans, or using retained earnings.

Question 8

What is the Agency problem?

Answer 8

The conflict of managerial objectives with shareholder objectives

Question 9

What is corporate govenance?

Answer 9

Corporate governance is the system of rules, practices, and processes by which a company is directed and controlled.

Question 10

What are the internal parts of corporate governance?

Answer 10

Board of directors
Management

Question 11

What does management do for a company?

Answer 11

Runs daily operations, implements board policies.

Question 12

What does the board of directors do for a company?

Answer 12

Oversees management, sets policies, hires/fires CEO, protects shareholder interests.

Question 13

What are the external parts of the structure of corporate governance?

Answer 13

Equity markets
Debt markets
Auditors and Legal advisors
Regulators

Question 14

What is the role of equity markets in the structure of corporate governance?

Answer 14

Provide ongoing valuations of a company’s shares
Enable the purchase of ownership

Question 15

What is the role of debt markets in the structure of corporate governance?

Answer 15

Ratings agencies review the ability of the firm to service (repay) debt

Question 16

What is the role of Auditors and legal advisors in the structure of corporate governance?

Answer 16

Provide an external opinion on the legality and conformity of financial statements

Question 17

What is the role of regulators in the structure of corporate governance?

Answer 17

They provide legal frameworks, ensure transparency and also protect shareholder rights

Question 18

What is corporate transparency?

Answer 18

The extent to which a corporation’s actions are observable by outsiders

Question 19

What are financial markets?

Answer 19

Any marketplace where the trading of securities occurs including the stock market, bond market, forex market and derivatives market

Question 20

What is the dealer market vs agency market?

Answer 20

Dealers buy and sell securities on their own behalf
Brokers act as agents in the agency market and buy/sell securities for someone else, they take a commission fee

Question 21

What are the major market indices in the Uk?

Answer 21

FTSE 100 (top 100 companies by market cap)
FTSE 250 (250 companies after top 100)
FTSE All share (aggregation of FTSE100, FTSE250 and FTSE SmallCap

Question 22

What is the EMH theory (Efficient Markets Hypothesis)?

Answer 22

Financial markets are “efficient,” meaning that prices of securities always fully reflect all available information.

Question 23

What are the three levels of information in EMH (Efficient Market Hypothesis)?

Answer 23

Weak form efficiency
Semi-strong form efficiency
Strong form efficiency

Question 24

What is weak form efficiency?

Answer 24

Past information (historical price records)

Question 25

What is semi-strong form efficiency?

Answer 25

Past information + Public information (earnings, dividends technology breakthroughs)

Question 26

What is strong form efficiency?

Answer 26

All relevant information private and public (insider information held by management of the company) Also past information and public information.

Question 27

What are the implications of the efficient market hypothesis?

Answer 27

Investors cant make consistent returns Companies cant time share issues Technical/Fundamental analysis and inside information cant be used to earn consistent returns For all forms (weak, semi-strong, strong)

Question 28

What is the difference between technical analysis and fundamental analysis?

Answer 28

Technical analysis examines past market data (past prices) Fundamental analysis analyses a company’s financial health, business model, competitive position, and economic environment

Question 29

What is an efficient market?

Answer 29

A market where all relevant information is fully reflected in security prices instantaneously and unbiasedly.

Question 30

What are some assumptions of market efficiency?

Answer 30

Random Walk Arbitrage Rationality

Question 31

What is Random walk?

Answer 31

Stock prices move in a random, unpredictable fashion, and future price movements cannot be forecasted using past price data. (slight positive drift over long term)

Question 32

What is Arbitrage?

Answer 32

The act of exploiting price differences through selling the overpriced security and buying the under priced security

Question 33

What is Rationality?

Answer 33

Investors behave rationally and value securities rationally, using fundamental values to calculate present values of future cash flows of a security by using models.

Question 34

What are some features of random walk?

Answer 34

Regular cycles for stock and commodities price movement don't exist Price changes are independent of one another

Question 35

What are the equations that show the central feature of random walk?

Answer 35

check ppt 01

Question 36

What is the difference between behavioural finance and traditional finance?

Answer 36

Traditional finance assumes investors are rational and markets are efficient, while behavioural finance recognizes that investors often act irrationally due to psychological biases, leading to market anomalies.

Question 37

What is loss aversion?

Answer 37

Disliking losses and liking gains

Question 38

What is overconfidence?

Answer 38

Overconfident investors believe they can consistently beat the market which leads to mispriced securities.

Question 39

What happens to arbitrage opportunities in a competitive market?

Answer 39

Will eliminate itself instantaneously and security prices will then reflect fundamental values

Question 40

What do different values of p (serial correlation coefficient) suggest?

Answer 40

p>0:Continuation - price increase today leads to increase tomorrow (vice versa) p=0: Uncorrelated p<0: Reversal - price increase today leads to drop tomorrow (vice versa)

Question 41

Describe the role of Fundamental Analysts

Answer 41

Research value of stocks Company data: using NPV and other cashflow measurements Risk estimates Industry + economic data

Question 42

What is the event study?

Answer 42

An event study analyses the abnormal returns around the time a specific event occurs, such as earnings announcements, mergers, product launches, or regulatory changes.

Question 43

What is some evidence against SSFE (semi-strong form efficiency)?

Answer 43

Post-earnings announcement drift - cumulative abnormal returns (CARs) drift for firms 60 days after announcement

Question 44

Overall is the market semi-strong efficient?

Answer 44

No, since 1980s lots of evidence otherwise

Question 45

Is SFE (strong form efficiency) supported in the market?

Answer 45

Not supported by existing evidence

Question 46

Give an anomaly of EMH where prices don't reflect information immediately

Answer 46

Under reaction: investors slow to the release of information (post-earnings announcement)

Question 47

Give an anomaly of EMH where prices change in a biased way

Answer 47

Small firm effect - small firms shares consistently outperformed large firms

Question 48

Give an anomaly of EMH where recurring patterns do exist

Answer 48

Weekend effect - abnormal returns tend to appear on Friday's

Question 49

Give an anomaly of EMH where prices don't reflect fundamental values

Answer 49

Bubbles - share prices deviate from fundamental values