financial institutions note

Chapter 7 forecasting share price movements Demand, supply and liquidity are primarily influenced by new information coming to the market Investment analysts tend to take one of three approaches when sourcing information: ●Fundamental analysis top-down approach → consider economic variables that may affect the future of an investment opportunity ●Fundamental analysis bottom-up approach →the historic and forecast performance of a specific investment opportunity ●Technical analysis →evaluates and interprets historic shear price movements over time Three theoretical concepts are introduced that seek to explain movements in share prices → 1. The random walk hypothesis→ recognises that SP movement respond to new information coming to the market → The path of a series of share prices is random and unpredictable →Each share is assumed to have an intrinsic value that is based on investors’ expectations about the present value of the firm’s future net cash flows →Share prices react to new info coming into the market, and therefore it is necessary to consider how quickly info is provided to a stock exchange and how quickly that info is absorbed and reflected in SP 2. The efficient markets hypothesi s → consider the provision of info to the markets and how quickly the markets and SP respond to new info →If markets are efficient, it should not be possible for an investor to make abnormal profits through having superior info to that of the rest of the mkt →Weak form efficiency →successive changes in the price of shares are independent of one another →investors cannot make superior profits through determine the share’s trading behaviour on the basis of historic price data → Semi-strong form efficiency → all publicly available info regarding a company is fully reflected in the price of a share →an investor couldn’t make superior profits using public available info because it is already reflected in the SP → Strong form efficiency → all info, including that which is publicly available and that which is available only through private inquiries and research, will be reflected fully in the market price of a share 3. The behavioural finance hypothesis →attempts to explain investor behaviour based on psychological principles of decision-making → The investor is more affected by negative news than by positive news → An investor may be inclined towards over-confidence in a rising market and over-pessimism in a falling market → Herding instinct → Trading noise Three categories: ●Heuristic behaviour → where investors do not seek to maximise returns on investment, but are quite willing to accept a lesser outcome or return ●Framing behaviour →investor is influenced by the manner in which an investment opportunity presented ●Market inefficiencies →other factors create mispricing that cannot be supported or explained by rational efficient market expectations Fundamental analysis seeks to id factors that are likely to influence directional changes in the value of a company and hence its SP → maybe macro or micro Macro → influence the overall market, such as i/r, economic g, business investment, consumer confidence Micro → firm specific, relate to financial and operational performance and strength of a company 7.1 Fundamental analysis top-down approach It is necessary to forecast and analyse the overall economic environment and consider how forecast changes in economic fundamentals will impact on the performances of various firms and industry sectors Having used the top-down approach to determine the better-performance industry sectors within an economy, the bottom-up approach should then be used to select the most robust firms within those industry sectors Seeks to id factors within an economy which may impact on the future performance and profitability of corporations → factors include growth rate of major international economies, e/r, i/r movement, growth rate of the economy, price rises, wages and productivity growth, government policy 7.1.1 international economies Rate of growth in major international economies can have quite a strong effect on the expected profitability of many companies within a domestic economy The higher the rate of growth in the rest of the world, the greater will be the demand for exports generally 7.1.2 the rate of growth of an economy Problems associated with rapid, unsustainable rates of growth in an economy include → deterioration of CA balance; increase in inflationary pressures; upward pressure on wages; depreciation of e/r; rise in i/r; inevitable downturn in economic activity and business cycle; 7.1.3 exchange rates If there were a strengthening, or appreciation, of the e/r of a local current against the USD, then profits from increased exports sales be less than if the exchange rate had remained constant. Firms that appear to have no contact with international trade may be affected by changes in the value of the domestic currency The deprecation in the e/r will put upward pressure on the rate of inflation in the economy A tightened monetary policy increases i/r or contractionary fiscal policy, cut govt 7.1.4 interest rates A rise in interest rates would signal a possible slowing of economic activity and also further reduction in profitability A forecast fall in interest rates would lead to an expectation of an increase in profitability, business activity and share prices Strong relationship between the level of exchange rates and the level of interest rates 7.1.5 the balance of payments current account A financial record of earnings from the export of goods and services to the rest of the world less imports, plus income earned on investments made overseas less the cost of overseas borrowings If CAD, it is necessary for a country to obtain funding from overseas →country building up its level of foreign debt and thus increases the interest payment burden of future years The faster the rate of growth, the more a country as a whole imports and the worse the CAD becomes → the level of foreign debt becomes greater → govt or CBA may take measures such as tightening of monetary policy → slowing the economy in order to slow import demand 7.1.6 inflationary pressures The CPI measures changes in the cost of a basket of selected goods and services that typify those bought by individual households in a particular nation-state Australia targets a level of inflation between 2-3% per annum over the business cycle Monetary policy → tighten monetary policy, interest rate rise to lower inflation Capital-asset-intensive companies may be particularly adversely affect by inflation 7.1.7 wages growth Wage increases that are in excess of an increase in the productivity of that labour will reduce the proportion of the company’s income revenue that goes to profit, and will render the company less attractive to SH and to potential investors Wages growth that is above the growth in productivity will reduce the profit margins of corporations 7.2 fundamental analyses: the bottom-up approach Considers micro factors that indicate a firm’s financial, operational and management performance The approach focuses on accounting ratios and other measures of a firm’s performance → Capital structure; liquidity; debt servicing; profitability; share price and equity; risk Modern portfolio theory →the greater the degree of systematic risk, the greater should be the expected rate of return → If a higher rate of return is not expected, then the higher risk is not worth accepting in the investment portfolio Drawbacks →the need to calculate the performance ratios using historic data →future performance might be different The fundamental analysis solution is to combine a top-down approach with the bottom-up approach 7.3 technical analyses Seeks to explain and forecast SP movements on the basis of the past behaviour of prices Most typically, analysts adopt either a technical approach or a fundamental approach: ●Moving-averages models ●Charting 7.3.1 moving-averages models The analyst creates a price series →the graph will show price changes over the period, and from that graph certain price trends may be evident Apply more sophisticated price models → constructing a moving-averages model (MA) from a series of numbers tends to smooth out more erratic price movements → it is designed to reveal more clearly the trends in a price series Once the actual price series and the MA series are plotted on the same graph → buy when the actual price series cuts the MA from blow (especially if the MA has been flat or is in a gentle decline) → buy when the MA series is rising strongly and the price series cuts or touches that MA from above, but then moves back above the MA after only a few observations → sell when the MA flattens, or declines after a steady risk, and the price series cuts that MA from above → sell when the MA series is in decline and the price series cuts or touches the MA from below, but then moves back beneath the MA after only a few observations The use of weighted MA→ most recent price contains the most valuable information on what the market perceives the value of the share to be → should carry the greatest weight in the calculation of the MA 7.3.2 charting Charting techniques →generating and interpreting buy/sell signals allows considerable scope for individual interpretation of the patterns that emerge in the charts ●Trend lines → Observe the trend and any changes that might occur in the trend → Uptrend line/ downtrend line → A return line is drawn parallel to the trend line in order to establish the trend channel →The longer a trend line has been in force, and the more times it has been tested, the greater is its validity → If a trend line is of long standing and has withstood three or four tests, and then an indecisive break is experienced, this penetration can be ignored and the original trend retained → Intra-day trades that break through established trend lines are considered to be unimportant; however, if the breakout is on high trading volumes it may signal a weakening trend →Failure to reach the return line in a well-established trend indicates deterioration in the trend → Once a trend is broken on the downside, price fall from it and then often make a return move towards the line. The pullback frequently retraces approximately 50% of the move away from the trend. The pullback provides a good sell point, if the trader has not already sold at the break of the trend ●Support and resistance lines → Support lines → occur at a price level where there is increasing demand, and sufficient volumes, to halt any further downward price movement → Resistance lines → occur at that high price level at which supply, relative to demand, is sufficient to halt a further advance in prices →A support/resistance pattern that is quite common in equity markets is the rectangle, which consists of sideway price fluctuations contained within the horizontal support and resistance levels. This pattern represents a period of conflict between buyers and sellers, with the price being bounced between the two lines ●Continuation patterns →They are believed to occur most frequently during a pause in the trend channel → Triangles →Symmetrical triangles are composed of a series of price fluctuations, with each top and bottom smaller than its predecessor; that is each minor top and bottom stops short of its previous levels →Ascending triangles usually form in a uptrend and are characterised by ascending bottoms and horizontal tops →volumes decrease during the formation but increase, often sharply, just prior to the usual upside breakout →Descending triangles usually form in a downward trend and are characterised by descending tops and horizontal bottoms →volumes decrease during the formation but increase just prior to the usual downside breakout. →Pennants and flags → Normally form in very fast moving markets → In a rising market this usually occurs after a very sharp increase in price on high volumes →During the formation of a pennant or flag, trading volumes fall and then increase suddenly to take prices sharply lower then higher respectively ●Reversal patterns p247 → A simple head and shoulders patterns consists of three successive rallies and reactions, the second rally reaching a higher point than the rallies on either side →Elliot wave theory contends that there are distinctive wave patterns that characterise share-market cycles 7.4 Electronic trading Program trading refers to buy/sell orders that are automatically triggered by computer-based share trading systems. Such automated programs may result in rapid share price changes which in turn may trigger further buy/sell orders. A number of stock exchanges, including the NYSE and the ASX, have rules in place whereby trading is suspended if the markets move by more than a specified percentage during a trading day. High-frequency trading (HFT) is the application of high-speed supercomputers that are controlled by algorithms that analyse data, identify investment opportunities, and influence stock order flows and therefore share prices in the market. Flash trading is a situation where certain privileged institutional investors, typically HFT firms, receive (are flashed) information from a stock exchange of incoming stock orders a fraction of a second before this information is sent to the exchanges trading system. Dark pools is a dedicated trading system that operates within an exchange that allows certain institutional investors to place large buy or sell orders without having to disclose the trade to the entire market. Program trading, high frequency trading, flash trading and dark pools all have an impact on share prices and therefore need to be considered when conducting analysis to forecast movements in share prices. Chapter 7 Forecasting share price movements ●The price of shares of listed corporations is a function of supply and demand ● 3 approaches: 1) Fundamental analysis top-down approach: economic variables that affect the future performance of an investment opportunity. 2) Fundamental analysis bottom-up approach: historic and forecast performance of a specific investment opportunity. 3) Technical analysis: evaluates and interprets historic share price movement overtime. ● 3 theoretical concepts that seek to explain movements in share prices: 1) Random walk hypothesis: new information coming to the market → share price moves 2) The EMH: considers the provision of information to the markets and how quickly the markets and share prices respond to new information 3) The behavioral finance hypothesis: psychological principles of decision making → investor behavior. ●New information →primary determinant of factors that affect the supply and demand for a stock. 7.1 Fundamental analysis: the top-down approach (page 239) ●Fundamental analysis seeks to identify factors that are likely to influence directional changes in the value of a company and hence its share price. ●Macro factors: influence the overall market, typically economic fundamentals (e.g. interest rates, economic growth, business investment and consumer confidence) ●Micro factors: firm specific and relate to the financial and operational performance and strength of a company, and also to the influence of management on a company’s performance. (e.g. ROE, return on assets, sales growth, market share). 1) Top-down approach: it is necessary of forecast and analyze the overall economic environment and consider how forecast changes in economic fundamentals will impact on the performances of various firms and industry sectors. Used to determine the better-performing industry sectors within an economy. Factors may impact on the future performance and profitability of corporations: (See ppt 关于艾滋病ppt课件精益管理ppt下载地图下载ppt可编辑假如ppt教学课件下载triz基础知识ppt ) - Rate of growth of major international economies - Exchange rate between a domestic currency and the currencies of major trading partners and competitors. - Interest rate movements - Rate of growth of the economy - Consumer price index - Rate of growth in wages and productivity - Government policy (domestic & international) 2) Bottom-up approach (page 245) - Used to select the most robust firms within those industry sectors. - Focuses on accounting ratios (e.g. capital structure, liquidity, debt servicing, profitability, share price and equity, risk) - DISADVANTAGE: using historic date to calculate ratios → future performance may be different. 7.3 Technical analysis (page 247) ●Based on the past behavior prices ● 2 types of technical analysis forecasting models: 1) Moving-averages models: the analyst creates a price series →show price changes over the period, and certain price trends. Smooth out more erratic price movements. It is designed to reveal more clearly the trends in a price series. Weighted MA: the sum of the five values is divided by the sum of weights 2) Charting a) Trend lines: - Uptrend line/ Downtrend line/ Return line - The longer a trend line has been in force, and the more times it has been tested, the greater is its validity. - If a trend line is of long standing and has withstood three or four tests, and then an indecisive break is experienced, this penetration can be ignored and the original trend retained. - Intra-day trades that break through established trend lines are considered to be unimportant; however, if the breakout is on high trading volumes it may signal a weakening trend. - Failure to reach the return line in a well-established trend indicates deterioration in the trend. - Once a trend is broken on the downside, prices fall from it and then often make a return move towards the line. The pullback frequently retraces approximately 50 per cent of the move away from the trend. This pullback provides a good sell point, if the trader has not already sold at the break of the trend. b) Support and resistance lines c) Continuation patterns: - Triangles: Symmetrical triangle: a series of price fluctuations, with each top and bottom smaller than its predecessor; that is, each minor top and bottom stops short of its previous levels. Transaction volume usually continue to diminish throughout this formation. Ascending triangles: volumes decrease during the formation but increase, often sharply, just prior to the usual upside breakout. Descending triangles: volumes decrease during the formation, but increase just prior to the usual downside breakout. - Pennants and flags: Normally form in very fast moving markets. In a rising market this usually occurs after a very sharp increase in prices on high volume. During the formation of a pennant or flag, trading volume fall and then increase suddenly to take prices sharply lower then higher respectively. d) Reversal patterns - Left shoulder: forms on an expanding volume-strong rally towards the end of an uptrend. This if followed by a reaction on quite reduced volumes. - Head: forms on a strong second rally, which carries the price higher than that for the left shoulder, and is followed by a reaction that see prices moving back to the vicinity of the previous low. - Right shoulder: conclusion of the pattern. The third rally is marked by reduced volumes and indicates price weakness. - Neckline: formed by a line drawn across the lows of the left and right shoulders. Completion of the pattern occurs when prices break through the neckline.