Bloomberg market concepts with perfect solution rated A+ Latest edition

2024

1. gross domestic product (GDP)

market value of all final goods and services produced within a country

GDP = C + I + G + (X-M)
C= personal consumption
I = private investment
G = government spending
X = exports
M = imports
(C = 2/3 of US GDP)

provides backdrop for investing bc is a measure of all economic activity

"actual GDP growth has entirely lost its capacity to surprise... leading indicators... PMI garners
disproportionate attention"

2. nominal GDP vs real GDP

nominal GDP = $ amount of GDP

real GDP growth = nominal GDP growth - inflation
(isolates increases in production and/or increases in prices of goods&services)

3. recession

2 successive quarters of negative real GDP growth

4. inflation

general increase in prices of goods&services which diminishes the purchasing power of money
(a unit of money tomorrow would buy less than the same unit of money today)

5. primary sources of inflation data

1) personal consumption expenditures (PCE)

^^ measure of price changes in consumer goods and services
^^ shows what consumers are spending their income on
2) consumer price index (CPI)
^^ based on a representative basket of goods&services
^^ difficulties w/ being truly representative bc times, interests, & tech change
^^ CPI basket is updated @ start of ea yr to reflect previous yr

6. unemployment

consumer spending is almost purely driven by salaries

^^ economy tends to shrink when more people lose their jobs (depresses GDP growth)
1) nonfarm payrolls
^^ most important unemployment indicator
^^ measures monthly change in # of US employees

7. business confidence

businesses make large investments and hire people when they feel confident there will be additional
demand for their goods&services

1) purchasing managers index (PMI)

^^ index of US manufacturing activity
^^ surveys people in charge of buying goods and services for corporations
^^ above 50 = optimism, below 50 = pessimism

8. housing

1) housing starts
^^ before construction begins, must be confident that future home buyers can assume 30 yr mortgages
^^ after buying a new house, consumer also purchases appliances, interior decorations, etc

9. main entities that trade currencies

1) financial institutions buying&selling securities in foreign currencies

2) corporations selling goods&services across borders
3) travelers changing currencies for personal use

10. pegged currencies

currencies that are linked to another currency with a locked exchange rate
^^ done to offer impression of certainty
^^ oftentimes difficult to convince others that pegged currency is as strong as peg

peg currency using FX reserves

^^ "a stack of cash used to manipulate supply and demand of currency"
^^ USD = most common FX reserve currency bc most liquid

govs also lift interest rates to defend pegs

11. triangular arbitrage

keeping currency matrix fixed so you can't make money converting between currencies

12. currency valuation

change in rate of one currency pair only tells relative value of those two currencies
^^ use trade-weighted baskets to determine overall strength or weakness of a currency
(identical goods&services should cost the same, no matter where they're sold around the world)

13. main currency drivers

1) surprise changes in interest rates
^^ rise in interest rates in one country will cause that country's currency to strengthen relative to
another
2) surprise changes in inflation
^^ money supply of one country expands rapidly compared to another country... exchange rate of first
country will depreciate against the second country
3) surprise changes in trade
^^ when exporting, foreign buyer needs to buy home currency of the exporter
(x-m) = positive = demand for home currency
^^ when importing, need to sell home currency in order to buy currency of foreign seller
(x-m) = negative = diminished demand for home currency

14. target inflation rate

2% for developed economy

^^ protects purchasing power
^^ keeps borrowing costs low

15. inflation is psychological

once price raising expectations are engrained, they're hard to unseat

workers expect price increases = workers demand pay increases = company wages go up = companies
raise prices

break cycle = interest rate hikes = sucks money out of system by making saving money relatively more
attractive

16. deflation is psychological

prices decline = consumers defer purchases to await lower prices = companies' revenues decline =
companies lay off workers to cut costs

break cycle = print money to buy gov bonds to raise inflation

17. currency inverse relationship

weaker currency = that country's exports are cheaper = exports are attractive to foreigners = that
country's companies get higher earnings

18. gold

traditionally a safe haven asset that people turn to in times of chaos

^^ durable perception of value through history
^^ not able to be manipulated by any gov (inflation hedge)
^^ non-yielding asset bc pays no dividends or interest

19. fixed income

the bond market
^^ setting price of borrowing/lending to govs, businesses, and investors
^^ bond = IOU that promises to make regular fixed amount payments (coupons) + large payment @ end
of loan (principal) + interest as compensation for lending
^^ biggest market in the world, bigger than world GDP and world stock markets

20. yield

"equivalent of interest rate on a bank account"

^^ difference: the rates on offer to new buyers of the bond will move as the price of the bond moves

yields make bonds comparable

inverse relationship between price and yield

elevated bond yields may force govs to enact budget cuts or tax hikes

21. perpetual bond

bond in which principal is never repaid

^^ price and yield are perfect mirror image

22. bond winners & losers

new lenders + high yields = +

new lenders + low yields = -

new borrowers + high yields = -

(would have to promise to pay back relatively more to secure a loan)
new borrowers + low yields = +

23. servicing debt

paying coupons

24. bond valuation drivers

CREDIT RISK
1) debt / GDP
2) deficit / GDP
3) repayment schedule
4) credit ratings
5) credit default swaps

MACROECON
1) short-term interest rates
2) inflation

25. credit risk

"bond prices reflect belief in payment likelihood tomorrow" (solvency fears)

"as investors doubt the creditworthiness of a borrower, they expect to be paid less in the future, so the
price of the bond decreases... the calculation of yield assumes all planned cash flows will be made, so
the yield from a lower cash outlay will be higher"

26. debt / GDP

"gov debt as a proportion of GDP"

no preordained debt / GDP value @ which bond market will panic

repaying debt doesn't count as part of GDP

^^ GDP growth from goods&services borrowed money was used to procure has already occurred
^^ gov borrowing and spending drives GDP growth
^^ debt repayments inhibit GDP growth

the higher a govs debt burden in proportion to its GDP, the riskier its bonds

27. deficit / GDP

"budget deficit as a proportion of GDP" (extent to which gov is living beyond its means)

for govs with deficits, this ratio will be negative

^^ higher ratio = gov is racking up debt faster (investors will demand higher yield bc of elevated risk)

size of budget funding gap that needs to be plugged by bond market

28. repayment schedule

will borrower have cash available when repayments are due?

borrowing in short-term = lower annual interest rate bc of lower risk

^^ bulk of US borrowing is short-term
(US prints world reserve currency and has ability to tax wealthiest population and corporations)

borrowing in long-term = open to only most credit-worthy companies

29. credit ratings

S+P 500: highest = AAA, lowest = D (default)

track record for credit rating agencies it patchier for corporate bonds than government bonds

BBB corporate bonds and above are "investment grade"

^^ BB+ and below are "non-investment grade," "speculative," "high-yield," "junk"
75% of BBB rated bonds defaulted within 10 yrs
^^ 94% of CCC rated bonds defaulted within 10 yrs

30. credit default swaps

popular alternative to monitoring credit ratings

^^ more timely warning of default bc real-time readings based on traded instruments

higher CDS spread = higher risk

31. short-term interest rates

cutting short-term interest rates lowers bond yields

^^ price would increase to equalize

lifting short-term interest rates increases bond yields

^^ investors sell bonds until price equalizes

32. inflation (bonds)

inflation has a corrosive effect on price of fixed income instruments

^^ impacts of inflation are compounding

correlation btwn inflation and bond yields

(high inflation = high yield)

bond yields are nominal, not real, bc don't adjust yield calculation for inflation

winners & losers from inflation:

lenders + inflation = -
lenders + deflation = +

borrowers + inflation = +
(inflate away debt... monthly payments become less of a burden... employer raises salary to keep up w/
increased costs of living)
borrowers + deflation = -

33. potential causes of inflation

1) excessive economic growth

(deflation can be caused by lack of economic growth)
2) war = most extreme inflation
(bc printing money to buy weapons)

34. TIPS

treasury inflation protected securities

^^ compensate lender in case of inflation using CPI as a guide
^^ exception to fixed income instruments being corroded by inflation
^^ higher inflation expectation = greater demand for TIPS relative to normal bonds

35. central brank decision-making

central banks set interest rates to protect currencies from inflation

1) inflation measures
^^ GDP deflator, CPI, PCE (fav gauge of fed)
2) the output gap
^^ difference btwn economy's potential output and its actual output
^^ tightness = inflation, slackness = deflation
^^ output gap % = (actual output - potential output)/potential output

36. central bank toolkit

1) short-term interest rates

^^ tool to combat positive output gap
^^ when short-term interest rates go up, more attractive to deposit cash
(dissuades consumption and investment)
2) statements
^^ expectations underpin all market prices
^^ futures & options market allows us to determine the probability of certain FOMC decisions

37. 4 most influential central banks

1) federal reserve - US
2) bank of england - UK
3) ECB of europe - eurozone
4) bank of japan - japan

38. yield curve

x-axis doesn't signify passage of time, but rather bond's maturity

has a positive slope bc longer maturity bonds have higher yields

^^ difficult to predict inflation farther into the future
^^ more expensive to borrowers bc greater chance of borrower going bust and more exposure to
inflation

left-hand end of yield curve is federal fund's target interest rate

39. term premium

difference btwn yields on longer maturity bonds and shorter maturity bonds (as a %)

40. spread

how much more a business pays to borrow money than the gov
^^ companies are typically less credit worthy than govs
^^ corp bonds have higher yields than gov bonds at same maturity

bigger spread = widening, cheapening, steepening, underperforming of the bond

narrow spread = tightening, richening, fattening, outperforming

41. yield curve transmission mechanisms

1) corporate impact = almost all corporate investment projects are multiyear, and are therefore funded
w/ medium-long-term borrowing

2) consumer impact = disproportionate impact of housing on US economy and behavior of consumers

^^ most home buyers in US get 30 yr fixed rate mortgage priced on 10 yr gov bond yields
^^ gov bonds impact affordability of homes

3) global impact = yield curves of major economies are strongly correlated

42. long-term yield drivers

1) interest rate forecasts

2) GDP growth estimates
3) demographics
4) demand for borrowing
5) supply go long-term lending
6) inflation expectations

43. fed overnight interest rates

yield on bonds w/ a 24 hr maturity

44. yield curve as an economic indicator

sell bonds in anticipation of inflation rises & rate hikes

buy bonds in anticipation of falls in inflation & rate cuts

STEEP: (natural)
classic sign of an accelerating economy
^^ expected boom = expected inflation = rises in short-term interest rates
^^ long-term bonds are better economic indicators bc short-term interest rates are tethered to fed
funds rate

FLAT:
lifting short-term interest rates = people preparing for economy to slow & fed to cut rates = bond prices
go down & yields go up = investors aggressively buy long-term bonds = offsets upwards slope of yield
curve

INVERTED:
(normally precedes recessions... only 1 false positive since 1970)
fears of impending downturn = people buy medium-long-term bonds that benefit from rate cuts
^^ negative term-premium

45. purpose of stock market

allocating resources to productive enterprises

^^ by buying shares in a company, you will ultimately earn the underlying commercial returns of that
company

46. bull & bear

bull market = optimism (up)

bear market = pessimism (down)

47. circuit breakers

halt trading if S&P 500 declines 7% from closing price of previous day

48. why do companies go public

1) raise money to expand business

2) enable founders / owners to sell their stocks to the public
^^ some companies trade @ all-time high @ IPO

49. why do companies delist?

in recent years, # of listed companies has gone down

1) bought by private equity fund
2) management is fed up w/ regulatory burden of being a public company
3) company went bust / industry died

(not all delistings are for negative reasons... ex whole foods delisted when it was bought by amazon)

50. indices

investors keep tabs on stock market by looking @ indices

(can also tell you when a money manager has beaten the market)
^^ indices = baskets of stocks
^^ constituents = single stocks

organizing principles:
1) company size
2) industry
3) country
^^ many indices are broken down by geography
^^ while an index may be domiciled in one country, the companies contained therein may have
revenues coming from many other countries
(ex: 1/3 of S&P 500 members come from outside US)

indices understate volatility bc positive contributions of some members offsets negative contributions of
others

S&P 500 = most watched index bc accounts for 1/4 of world's market cap

51. 11 industry groups

communication services, energy, real estate, consumer discretionary, utilities, materials, information
technology, consumer staples, industrials, health care, financials

52. market capitalization (market cap)

total value of shares outstanding

^^ # of shares of company x price per share = size of company
^^ can have same market cap w/ thin or thick slices
^^ when a stock doubles or halves, when know that market cap has doubled or halved

53. how much a stock contributes to moves in an index

index weight (%) = market cap of 1 stock ($) / market cap of all stocks in index ($)

index level x index contribution of company (%) = points contribution of company

points contribution of company x (1 + % stock price move) = new points contribution of company

new points contribution of company - old points contribution of company = index move contribution

overall index move = adding up all individual positive and negative points contributions

54. equity

an entitlement to future cash flows

^^ promises residual cash flows & what is left after all other claims have been satisfied
^^ other claims = payments to suppliers, employee compensation, repayments to lenders, gov taxes

55. dividends

regular cash payments to shareholders that come from company's after-tax earnings

most equity indices ignore dividend payments

^^ returns calculated from indices are lower than what investors usually get

can re-invest dividends

company management is loathe to cut dividend payments bc many share-holders rely on them when
they retire

56. stock & bond indices are nominal

stock & bond holdings need to perform in line w/ inflation just to stand still
^^ shouldn't be impressed w/ single-digit returns
^^ should compare stock & bond returns to nominal GDP growth

57. differences btwn bonds & equities

bonds = right to known fixed repayments = contracts

equities = right to unknown residual earnings = full ownership

bonds = most you can lose is everything if borrower doesn't make repayments
^^ however, lender typically receives many coupon repayments before bankruptcy
^^ bond-holders are also first in line to recover everything
^^ most you can gain on a bond = yield calculated @ time you bought = likely sing-digit annual return

equities = most you can lose is everything when share price goes to 0 = no right to collateral
^^ most you can gain on an equity = theoretically unlimited upside

58. what exactly do share-holders own?

1) earnings company generates after paying off expenses

2) sum total of company assets not owed to lenders (net assets)

59. how to calculate earnings

earnings = revenue - costs

^^ revenue = income before deducting expenses
^^ earnings = profits
^^ companies report these #s on a quarterly basis... 3-4 wks after quarter is over
(will move markets if #s are a surprise)
(earning season is more evergreen than deciduous)

60. how to estimate company earnings

1) industry classification
2) suppliers & buyers
3) revenue projections
4) cost base

61. industry classification

consistency of revenue & costs differ btwn industries

some companies operate in multiple industries

(can breakdown revenues by industry)

over 2000+ global industries that are arranged hierarchically

62. suppliers & buyers

know customers and how well they're doing

potential supplier problems = bankruptcy, product problems, currency movements

^^ not only supplier to customer means has competitors

63. CAPEX

portion of customer's capital expenditure (money spent on high-value purchases) that went to a
company in a Q

64. revenue projections

how big is the pie? how big is the company's slice of that pie?

how well is the market doing? is company gaining or losing market share re competitors?

65. cost base

which costs are fixed? which are variable?

^^ cost of labor, cost exposures to commodity prices

66. 1st steps to generating financial estimates for a company

analyze historic performance using "actuals"

(reported #s)

1) examine previous earnings statements

2) read transcripts of recent company-investor conference calls
(esp management's Q&A w/ analysts)
^^ what guidance has company management provided re performance?

67. earnings results

beat = actual results > surprise

miss = actual results < surprise

(surprise relationship isn't foolproof... stock price can rise after a negative surprise)

68. stock split

share price is too high for retail investors

^^ divide each share into 2+ shares

69. reverse stock split (stock consolidation)

putting multiple shares together into one share

70. stock buybacks

value of each stock remaining in market goes up bc now fewer stocks in market

show that company has faith in itself = may cause investors to buy more stock

71. absolute valuation

estimate how much estimated future earnings are worth in today's money

PROS:
1) precise = rests on detailed assumptions about future
2) anchored by earnings = derived by profit generated by company
3) disciplined thought process = must think through whole business model

CONS:
1) demands clairvoyance
2) laborious = detailed model of company's revenue & costs
3) prone to subtle manipulation bc of assumptions
(can provide a desired answer)

72. relative valuation

comparing a company to a similar company, overall market, or to itself

PROS:
1) easier to understand
(like comparing loaves of bread at a store)
2) simple to calculate
3) doesn't demand long-term forecasts, typically only 1 yr

CONS:
1) directional = opinion is that company is undervalued / overvalued / fairly valued, but no estimate of
how much the company is actually worth
2) hard to find truly comparable companies
3) presupposes that comparison company is itself fairly valued

73. 5 steps of absolute valuation

1) understand historic performance = estimate long-term future cash flows

2) estimate discount rate (WACC) = how much to discount those cash flows in order to derive today's
value
3) take estimated future cash flows and discount by the WACC
4) deduct the firm's indebtedness and add firm's cash pile to derive market cap
5) divide estimated market cap by # of shares to give estimated fair share price

74. WACC

weighted annual cost of capital

WACC = W X C
^^ W = weight
^^ C = cost
^^ need to add this calculation for equity & debt together

higher WACC = cash flows valued at far less

10 yr gov bond yields are fundamental in WACC

^^ lower 10 yr gov bond yields = lower WACC = higher estimated share price

75. AV step 1

need to project free cash flow

^^ cash that firm has available for both bond-holders & share-holders

76. AV step 2

(investors assign a lower value to the future)

US gov bond yields help set discount rate for equity investors
^^ but, unlike govs, companies don't have tax payers or money printing to fall back on... discount needs
to be greater than gov bond yield rate

discount rate for overall firm = blend of discount rates for equity & debt in proportion to relative split of
equity & debt financing
(remember unlisted debt instruments such as bank loans)

77. capital asset pricing model (AV step 2)

volatility of stock being valued compared to overall market volatility to calculate stock specific risk

1) take 10 yr gov bond yield

2) calculate historic overall market return
("we can expect a return of _____ % from US stock market")
3) calculate premium = market return - 10 yr gov bond yield
4) estimate beta
^^ sensitivity of stock relative to sensitivity of overall stock market
^^ daily returns of S&P 500 on x-axis, daily returns of company on y-axis
^^ estimate line of best fit, beta is slope of this line
^^ higher beta = steeper line of best fit = stock moves in exaggerated way relative to market
5) multiply beta by expected market return to get "equity risk premium"
6) add back risk free rate to equity risk premium

78. AV step 3

estimated value is total of discounted cash flows

79. AV step 4
EV accounts for $ of both bond-holders & share-holders
^^ need to subtract value of bond-holders stake to get EV
^^ calculated from trading value of bonds or from value of debt on balance sheet
^^ need to add bank cash balance bc not calculated in earnings forecast

80. enterprise value (EV)

value of whole firm

EV = market cap - cash + debt

81. AV step 5

divide estimated market cap by # of shares

82. if a company has been around for a long time, why isn't its share price extremely high?

in long-term, no company can grow faster than nominal GDP growth, or it would subsume global
economy
(WACC > nominal GDP growth)

83. "AV will lull you into a sense of security"

sensitivities:
1) revenues & costs may be in other currencies... buffeted by moves in FX market
2) many companies are impacted by commodities markets
3) moves in 10 yr gov bond yields change "risk-free" rates
4) share price itself can impact share price... a company w/ a rising share price can raise funds for
growth more easily

84. dividend yields (RV)

dividend yield % = $ dividend per share / $ price per share

(normally use 1 yr of dividend yields for comparability purposes)

earnings yield % = $ earnings per share / $ price per share

^^ usually higher than dividend yield

share price = earnings per share / earnings yield

85. P/E ratio (RV)

(reciprocal to earnings yield)

P/E ratio = $ price per share / $ earnings per share

(result should be in x, as in times, and should be written to one decimal place)
^^ prospective P/E ratio uses estimated earnings per share for upcoming calendar yr

share price = E x P/E ratio

^^ E = earnings
^^ E's cancel to leave P

market cap = net income x P/E ratio

"rapidly growing companies can grow into very high P/E ratios... but high P/E ratios don't automatically
make stock expensive"
^^ low P/E ratio = low growth expectations

P/E ratios are subject to reversion to the mean law

(corporate earnings are not subject to this law... could hypothetically pay unlimited dividends)

86. how P/E ratio impacts share price

SHARE PRICE GOES UP...

1) earnings growth = P/E ratio stays the same, but E gets bigger
2) multiple expansion = P/E ratio goes up, but E stays the same

87. RV vs self

how has the company's metric trended over time?

^^ look at P/E ratios in context of earnings
^^ look at historic P/E ratio

88. RV vs peers

measure premium or discount to P/E peer group ratio

(classically understood RV)

which companies are peers?

same industry & region... ideally direct competitors
^^ face same risks
^^ use table of comparables ("comps table")
^^ snag: peer company may be part of conglomerate that operates in many industries... conglomerate
may only have one P/E ratio
^^ snag: private vs public companies
(private companies have no P/E ratio)

89. RV vs market

use P/E ratio of S&P 500, or whichever regional index is relevant

^^ use dividend yield (DyYld) of same index

90. valuation of market

for S&P 500:

P = E x P/E
P = aggregate market cap for all index members
E = total net income for all index members
P/E = aggregate market cap for all index members / total net income for all index members
earnings and stock market (aggregate market cap) move in tandem
^^ turns in earnings trend precede turns in stock market

91. world GDP keeps growing & growing

snag: stock markets are exposed to their home economies... one must be confident in economic outlook
of that country
^^ need view on demographics, productivity, & technology
^^ therefore can't say that stocks always go up in long-run