[Music] there are four phases to the business cycle expansion peak contraction and trough a recession is at least two consecutive quarters of decline in gdp a depression is at least six consecutive quarters of decline in gdp there are four types of industries growth cyclical counter cyclical and defensive growth industries pay low to no dividends and represent an opportunity for appreciation defensive industries resist market cycles alcohol tobacco pharmaceuticals oil and gas and public utilities are all defensive industries cyclical industries do well during an expansion examples of cyclical industries include steel heavy equipment capital goods home appliances and the auto industry counter cyclical industries expand during a contraction golden mining stocks are generally counter cyclical congress and the president are in charge of fiscal policy fiscal policies include changes in tax laws and budgetary changes the federal reserve is in charge of monetary policy the main tool of the federal reserve is its open market operations the fed will buy u.s government securities to stimulate the economy this practice is called quantitative easing the fed will sell u.s government securities to rein in inflation this process is called quantitative tightening the federal reserve controls two key interest rates the federal funds rate and the discount rate the federal funds rate is the most sensitive indicator of interest rate direction the federal reserve sets a target rate for the federal funds rate the federal funds rate is the rate in which a member bank will lend another member bank for an overnight loan to meet reserve requirements it is the shortest term loan the discount rate is set by the federal reserve it is the rate in which the fed will lend money to a member bank from their window commercial banks set their own prime rate in response to changes in the target for the federal funds rate and the discount rate a bank's best commercial customer would get a loan at the prime rate lowering of interest rates is done to stimulate spending it is an example of expansionary monetary policy raising of interest rates is done to slow down spending this is an example of contractionary monetary policy the federal reserve also sets banks reserve requirements the reserve requirement is how much cash the bank must have on hand there are four macroeconomic theories keynesian classical monetarist and supply side keynesian economists believe that lower levels of taxation and higher government spending can get the u.s out of a recession classical economists believe that the less government regulation the better a lays a fair approach they believe in the efficiency of free markets to generate economic development monetarists believe that the amount of money in circulation determines overall price levels and economic activity and can be used to help the u.s rise from a recession supply-side economists believe that economic growth can be most effectively created by lowering taxes and decreasing regulation the yield curve plots the yields of u.s government securities beginning with the one-month treasury bill through the 30-year treasury bond in a positive normal yield curve the line slopes upward the lowest yield is found on the debt maturing in the near term with the highest yield being on the debt maturing in the long term in a flat yield curve there is no slope in a negative inverted yield curve the slope is downward the lowest yield is found in the debt maturing in the long run and the highest yield is on debt maturing in the short term the credit spread shows the difference in yield between u.s government debt and corporate debt of the same maturity if the credit spread should widen this is a negative indicator when it narrows this is a positive sign trading of currencies occurs in the 4x marketplace it is an over-the-counter 24-hour market sovereign debt is debt of a foreign country cpi is the consumer price index it is how we measure inflation inflation is a general increase in the cost of goods its root cause is too many dollars chasing too few of goods deflation is a general drop in the price of goods its root cause is too few of dollars chasing too many goods constant dollars are indexed for inflation whereas current dollars are not gdp is gross domestic product it is the value of goods and services produced within a country's borders gnp is gross national product it is the value of goods and services produced by a country's residents regardless of their location balance of payments is a country's accounting record with the rest of the world money flowing into a country is a credit whereas money flowing out of a country is a debit the balance of trade compares a country's imports versus its exports when a country imports more than it exports it will have a balance of trade deficit when a country exports more than it imports it will have a balance of trade surplus countries with a persistent current account deficit such as here in the united states are effectively exchanging goods and services for foreign investments the federal budget is an example of fiscal policy a balanced budget occurs when revenues are equal to expenses a budget surplus occurs when revenues exceed expenses a budget deficit occurs when revenues are less than expenses economic indicators are used to determine which phase of the business cycle the economy is in leading indicators show us where the economy is heading in the next four to six months leading indicators include average manufacturing workers work week building permits money supply initial unemployment claims manufacturers new orders for consumer goods and non-defense capital spending index of supplier deliveries s p 500 spread between the 10-year treasury and the federal funds rate and the index of consumer expectations coincident indicators current change directly at the same time as the current phase of the business cycle coincident indicators include industrial production personal income non-agricultural employment and manufacturing and trade sales in constant dollars lagging indicators take four to six months to reflect a change so that the economy is in the next phase before these indicators change lagging indicators include average duration of employment total amount of commercial and industrial loans outstanding ratio of consumer installment credit to personal income changes in the cpi for services average prime rate and change in the index of labor cost per unit of output financial reports include the income statement also called the profit and loss balance sheet and statement of cash flow fundamental analysts review a company's financial statements when considering an investment the income statement shows a company's income and expenses over a period of time usually a year gross profit margin takes a company's income and subtracts out cost of goods sold gross profit margin as a percentage would be gross revenue minus cost of goods sold divided by gross revenue dividends are paid out of a company's after tax income the balance sheet shows what a company owns assets and owes liabilities as of a moment in time like a snapshot the balance sheet equation is assets equals liabilities plus shareholders equity a client's assets minus liabilities equals the client's net worth a company's assets can be broken down into current assets fixed assets and intangible assets current assets are cash or items expected to be cash in the next 12 months including accounts receivable marketable securities owned by the company and inventory fixed assets have a physical property and must be written down over time fixed assets include land buildings and machinery intangible assets include intellectual property patents pending and goodwill a company's liabilities can be broken down into current liabilities and long-term liabilities current liabilities are monies owed in the next 12 months and include accounts payable accrued wages accrued interest and accrued taxes long-term liabilities include mortgages payable bonds payable and any monies that are owed in more than 12 months shareholders equity includes the following four components preferred stock at par common stock at par paid in surplus and retained earnings footnotes are found at the bottom of the balance sheet the statement of cash flow takes a company's net income or net loss and adds back the non-cash items of depreciation depletion and amortization it is possible for a company to have a negative income in the same year that it has a positive cash flow due to the effects of depletion depreciation and amortization the capitalization of a company includes the long-term debt and the shareholders equity the sec requires publicly traded companies to file financial information through the edgar system 8k filings are required within four business days of a significant event companies must file three ten queues these are quarterly reports that include unaudited financial data companies must file one annual 10k it includes audited financial data the 10k must include the auditor's disclosure the auditor must be an independent cpa the auditor's report will include the auditor's opinion the opinion will be qualified unqualified or no opinion in a qualified opinion there is financial information that the auditor does not agree with in an unqualified opinion the auditor agrees that the financial information accurately reflects the financial position of the company an auditor will write no opinion when they are not given access to the financial information necessary to form an opinion shareholders of publicly traded companies receive an annual report each year that includes audited financial statements it is more of a marketing piece than the 10k filing mutual fund shareholders receive two reports a year as semi-annual report and an annual report included in the semi-annual and annual report is a summary portfolio schedule management's discussion of fund performance must be included in the annual report along with audited financials in a cash basis accounting system income is booked when received and expenses are booked when paid in an accrual basis accounting system income is booked when invoiced and expenses are booked when the bill is received beta is used to measure the variability between a specific stock's rate of return and the market as a whole if a stock has a beta of positive one it moves with the market when a stock has a beta of negative one it moves the opposite of the market a beta of more than zero but less than one is a defensive issue that is not as volatile as the market beta measures a stock or a portfolio relative to the s p 500 the market as a whole financial ratios are used by fundamental analysts for comparison purposes the current ratio formula is current assets divided by current liabilities it is a measurement of liquidity the quick ratio is also called the acid test ratio it is the most stringent measurement of liquidity the formula is current assets minus inventory divided by current liabilities the debt to equity ratio is a measurement of leverage the formula is debt divided by debt plus equity the formula for working capital is current assets minus current liabilities it measures how likely could a company withstand a short-term economic downturn the formula for earnings per share is earnings available to common divided by number of shares of common stock outstanding valuation ratios are used to compare companies in the same industries the formula for the price earnings ratio is current market price divided by earnings per share growth stocks have high price earnings ratios since they have low to no earnings value stocks have low price to book ratios blue chips have higher dividend payout ratios than growth companies the formula for current yield on a stock is annual dividends divided by current market price the formula for current yield on a bond is annual interest divided by current market price the risk-free return is the rate of return on the 13-week treasury bill standard deviation measures the dispersion around and average it is the mean of the means the lower the standard deviation the more likely the past returns will repeat themselves in the future the sharp ratio measures risk adjusted return its formula is actual return minus risk-free return divided by standard deviation if two stocks have a perfect positive correlation of positive one then their returns will be the exact same if two stocks have a perfect negative correlation of negative one then their returns will be the exact opposite mean means average median is the middle number mode is the number that appears most frequently range is the difference between the highest and the lowest number a dollar today is worth more than a dollar in the future due to the time value of money when the net present value of an investment is zero the discount rate being used is the investment's internal rate of return if the investment's internal rate of return exceeds the client's hurdle rate then it is a worthwhile investment the internal rate of return on a bond is its yield to maturity if the net present value of an investment is positive then it is an acceptable investment when the net present value of an investment is negative then it is not a worthwhile investment the highest net present value occurs when the discount rate being used is zero the higher the discount rate the lower the npv the rule of 72 can tell you how long it will take an investment balance to double when the rate of return is known 72 divided by the rate of return will tell you the number of years it will take for the money to double using the rule of 72 you can determine how much an investment must earn in order for the money to double in a given period of time 72 divided by the number of years invested equals the rate of return needed for the money to double a portfolio's total risk is made up of two types of risks systematic and unsystematic risk standard deviation accounts for both the systematic risk and the unsystematic risk found in an investment systematic risk is borne by the system and cannot be reduced by simply diversifying a portfolio there are three types of systematic risks market risk inflation risk also called purchasing power risk and interest rate risk to diversify by asset class reduces systematic risk asset classes include stocks bonds real estate and cash when invested in an s p 500 fund the client is exposed to market risk bonds have interest rate risk holding a bond until maturity avoids interest rate risk but exposes the investor to purchasing power risk inflation risk fixed income securities have purchasing power risk common stocks and variable annuities are hedges against inflation unsystematic risks are stock specific unsystematic risks are also called non-systematic risks diversification helps with unsystematic risks diversification means to own lots of different companies stocks the following are unsystematic risks business risk financial risk also called default risk or credit risk call risk reinvestment risk regulatory risk legislative risk political risk country risk sovereign risk currency exchange rate risk and liquidity risk legislative risk is the risk that tax laws could change regulatory risk occurs when a business is accused of breaking a law credit risk is the risk that the issuer could experience financial difficulties that make it unable to pay the interest and principal on a bond credit risk is also called default risk or financial risk business risk happens due to poor management decisions and is unrelated to the financial health of the company bonds have reinvestment risk at maturity as do bank cds callable bonds have call risk the risk that if interest rates fall enough the issuer could choose to pay off the bondholder early political risk is related to elections and government coups country risk is related to an investment in a specific country sovereign risk is related to owning debt of a foreign government owning foreign investments exposes a client to currency exchange rate risk there is no secondary market in which to sell units of a direct participation program these units have liquidity risk opportunity cost is the return that the client loses out on when they choose a riskier investment than the risk-free return and earn less than the risk-free return sunk costs are monies already spent that you cannot get back in the event of a corporate liquidation secured creditors are paid first then unsecured creditors next preferred stockholders and then common stockholders if there were any foreign investors they would be paid after common stock [Music]