CMFAS Module 6 Key Note Set 2
Fiscal policy refers to the use of government taxation and expenditure policies to influence aggregate demand and supply. The government withdraws money from the economy as a whole through taxation, and injects it back through government spending.
2. What stages that an industry can go through overtime?
Over time, the development of an industry can be divided into five stages:
• Early development
• Rapid expansion
• Mature growth
• Stabilisation and market maturity
• Deceleration of growth and decline
3. What are the competitive forces that determine the industry profitability?
5 basic competitive forces that determine the industry profitability:
• Rivalry among existing competitors
• Threat of new entrants
• Threat of substitute products
• Bargaining power of buyers
• Bargaining power of suppliers
4. What are the economic indicators used to give warnings of changes in the economic activity?
Economic indicators are used to give early warnings of changes in economic activity.
There are 3 major types of economic indicators; the leading indicators, the coincident indicators and the lagging indicators.
Investors should be aware of political developments such as elections, changes in political leadership, dissent in a particular party and stated party policies and guidelines.
To predict the performance of an industry, investors should carefully analyse the stage of the business cycle and its likely responses to changes in the economy which may be as diverse as the balance of payments, the trade account, inflation and unemployment.
7. Why is tehcnical analysis also called market or internal analysis?
Technical analysis uses charts, technical trading rules and indicators. It is sometimes called market or internal analysis because it studies demand and supply conditions based on market data such as price changes and trading volume.
8. What are the assumptions underlying technical analysis?
The assumptions underlying technical analysis are:
i. A security’s market value is determined only by its supply and demand;
ii. Supply and demand is affected by both rational and irrational factors. These factors include not only economic variables employed by the fundamental analysts but also hopes, fears, opinions, moods and guesses of numerous potential buyers and sellers. The market weighs all these factors automatically and continually;
iii. Prices of individual securities and the overall market move in trends, which tend to persist over an appreciable length of time;
iv. Trends develop in reaction to changes in the supply demand balance. Such changes can be detected in the action of the market itself; and
v. Chart patterns tend to repeat themselves.
9. Whaat sort of movements does the Dow Theory postulates?
The Dow Theory postulates 3 movements in the market: the primary movement, the secondary movement, and the daily fluctuations.
10. How many types of charts can be used as a tool for a technical analyst?
Charts are the technical analyst’s main tools. There are different charts, which suit different types of analyses. Some of these include:
• Line charts
• Bar charts
• Candlestick charts
• Point and figure charts
11. What elements are there in the porfolio management process?
The portfolio management process for individual investors is a dynamic, continuous and systematic one with the following elements:
a. Setting investment objectives.
b. Developing and implementing strategies.
c. Monitoring market conditions.
d. Reviewing and adjusting the portfolio.
e. Measuring investment portfolio performance.
12. What should a typical investment policy statement (IPS) include?
A typical investment policy statement (IPS) will include the following:
1. Introduction – describes the investor;
2. Statement of purpose – expression of the purpose of the IPS;
3. Statement of duties and responsibilities – lays down the respective duties and responsibilities of the client, the custodian of the client’s assets and the investment manager;
4. Procedures – sets out the processes for maintaining and updating the IPS;
5. Investment objectives – e.g. capital appreciation, income generation or wealth preservation;
6. Investment constraints – e.g. liquidity requirements, time horizon, tax considerations, regulatory and legal requirements, and unique circumstances peculiar to the investor);
7. Investment guidelines – provides guidance for the execution of the of the policy (e.g. is leverage permitted, are there loss limits, asset size limits, non-permissible activities or markets, and so on);
8. Evaluation and review – describes how evaluation and review of the portfolio will be carried out under the IPS;
9. Appendices on strategic asset allocation, rebalancing policy – investors often specify a policy portfolio (e.g. conservative portfolio, balanced portfolio or aggressive portfolio) as part of their investment objectives
13. Should a fund manager cinsider any tax implications for their clients?
To determine investment returns, the fund manager must consider the tax implications for their clients. Consideration must be given to:
• The client’s income tax bracket;
• Different tax treatments from different assets (tax-exempt or not); and
• Different components of total return (dividends or interest income versus capital gains).
14. Why is asset allocation considered important?
The purpose of the asset allocation process is to maximize return at a level of risk consistent with the investor’s objective within a portfolio. Asset allocation has a much greater impact on reducing total exposure to risk than picking an investment vehicle in any single asset category.
15. What are the main causes of systematic risk?
Systematic risk (also known as undiversifiable risk) results from factors outside the firm’s control. It is caused by factors such as changes in the economic, political and sociological environments, which affect the prices of all marketable securities.
16. What causes nonsystematic risk?
Nonsystematic risk (also known as firm specific risk) can be controlled and minimized through diversification. It is that portion of total risk that is peculiar to a firm or industry. Factors such as company strategies, management errors, new product developments and market innovations that impact on a company’s earnings potential cause nonsystematic variability of returns in a firm.
17. Can international portfolios can be constructed independently?
International portfolios can be constructed independently on two dimensions:
i. Geographical diversification by picking shares in all countries
ii. Diversification by selecting shares across industries
18. What assumptions is the Capital Asset Pricing Model (CAPM) based on?
The CAPM is based on the following assumptions:
i. Investors evaluate portfolios on the basis of risk and return.
ii. Investors are rational investors who want to maximize return for a given level of risk and minimise risk for a given level of return.
iii. Individual assets are infinitely divisible, which means that it is possible to buy or sell fractional shares.
iv. Investors can borrow or lend at the risk-free rate of return.
v. There are no taxes or transaction costs involved in buying or selling assets.
vi. There is no inflation or any change in interest rates, or inflation is fully anticipated.
vii. All investors have the same one-period time horizon.
viii. Information is freely and instantly available to all investors.
ix. Investors have homogenous expectations of risk, return and covariances of securities.
x. Capital markets are in equilibrium.
APT, like the CAPM, has the following assumptions:
i. Investors have homogeneous beliefs;
ii. Investors are risk-averse utility maximizers;
iii. Markets are perfect, so that factors like transactions costs are irrelevant; and
iv. Returns are generated by a factor model.
In contrast to the CAPM, the APT does not assume:
i. A single-period investment horizon;
ii. The absence of taxes;
iii. Borrowing and lending at the risk-free rate;
iv. Investors’ selection of portfolios on the basis of expected return and variance of return
21. What methods are known for measuring risk-adjusted returns?
There are 3 generally recognised methods of measuring risk-adjusted returns, also referred to as the composite measures of portfolio performance:
• Sharpe performance measure
• Treynor performance measure
• Jensen differential return measure
22. What are the most common composite measures of portfolio performance?
The most common composite measures of portfolio performance are:
• Sharpe measure which relates the portfolio’s excess return to the total risk (standard deviation) of the portfolio;
• Treynor measure which relates the portfolio’s excess return to the portfolio’s systematic risk (beta);
• Jensen differential return measure, which measures the difference between the portfolio’s actual return and the return that would be expected from the CAPM.
23. What are the advantages of price to book value ratios?
Advantages:
i. Book value is cumulative and is usually positive, unlike EPS;
ii. Book value is usually more stable than EPS, which can be more volatile; and
iii. Book value is well suited for companies with liquid assets however, non-performing loans will affect the book value of banks, and even the market values of liquid assets can change because of market factors.
24. What are the disadvantages of price to book value ratios?
Disadvantages:
i. Companies with intangible assets, such as patents and proprietary research knowledge, cannot be fairly measured using book value; and
ii. Accounting differences in the treatment of depreciation expenses or the impact on the book value of technology that has become obsolete.
25. What are the advantages of price to sales ratios?
Advantages:
i. Generally, sales figures are less subject to manipulation compared to earnings;
ii. Sales are positive, unlike EPS, which can be negative. This is useful for companies which are new start-ups and which have no earnings yet;
iii. Sales are more stable than EPS which could be quite volatile; and
iv. Suited for shares of mature companies, because these are likely to have more established markets, compared to a young company just starting out.
26. What are the disadvantages of price to sales ratios?
Disadvantages:
i. High sales revenues do not necessarily mean the company is profitable;
ii. Sales revenue practices, even where the sales numbers are not being manipulated within a company, can vary from one company to another, and may result in difficulty in comparing sales revenues between different firms;
iii. Expenses are not included, and this makes comparison between two companies with the same P/S ratio incomplete, or worse, misleading because the company with the lower cost structure actually means it is a better-managed company.
27. What are the adanatages of price to cash flow ratios?
Advantages:
i. Cash flows are less likely to be manipulated, compared to earnings.
ii. Cash flows are generally more stable than earnings.
iii. Cash flows are independent of accounting methods.
28. What are the disadanatages of price to cash flow ratios?
Disadvantages:
i. Non-cash items, such as deferred revenue, will not be taken into consideration.
ii. Cash flows can be from operating, investing or financing activities, and the choice of cash flow used will affect the valuation among companies.
29. When evaluating the prospectus, what should be noted with regards to the financial analysis?
When evaluating the prospectus, the following should be noted about the financial analysis.:
A financial analysis of its balance sheet, income statement and statement of cash flows should be conducted, using the financial ratios and equity valuation ratios, with special attention being paid to:
a. Overly rapid expansion of sales figures;
b. Inventory growing faster than sales;
c. Unusual fall in free cash flow; or
d. Aggressive acquisitions.
30. How can the debt securities market may be divided?
The debt securities market may be divided into three maturity segments based on the issue’s original maturity:
i. Money market instruments which are short-term issues of one year or less;
ii. Medium-term notes with maturities of more than one year but less than ten years; and
iii. Long-term bonds with maturities of usually ten years or more.