In this chapter we learned about the functions of security analysis: the descriptive function, the selective function, and the critical function.
In selecting securities to buy, you must first describe them, you do this by taking standard calculations provided by investment services, adjust them to find true operating results, and then compare them to others in the industry. (for those who do not know, securities include stocks and bonds)
In selecting senior securities, one will be sure that the company issuing the security has ample money to pay it back.
With common stock, there are two approaches. Some people believe that the market always prices stock correctly, while the approach we will be studying is different. We believe that the market is not always accurate, and that companies have an intrinsic value, separate from their current price.
I have created a worksheet and answers below for your studies.
1 - The three functions of security analysis are the descriptive, selective, and critical functions. When analyzing, one will follow this order. Explain the different levels one may use the descriptive function.
The descriptive function, at its surface level, consists of standard calculations usually given by the company to investment services. One can do a deeper analysis, which is the adjustment of these figures to reflect true operating results. At the deepest level, one ranks favorable and unfavorable factors of the issue, such as changes in position over the years, comparison to others in the industry, and future earnings assumptions.
2 - Explain the selective function, how senior securities are valued, and how common stocks are valued.
The selective function serves as a tool to select issues. For senior securities, the difference in valuation among analysts is not large. The usual method is to require an ample margin of safety in the past, which should protect against a bad future.
The difference in common stock is large. The anticipation approach is outdated. The value approach consists of finding an intrinsic value of the company and buying when significantly low. The usual method is to take the indicated average future earning power and multiply it by a capitalization factor. It is most useful in cases of extreme disparity between market price and value, and also when comparing with others in the industry.
3 -When the interest rate of a bond goes up, the price generally _____.
a) goes up
b) goes down
c) is unaffected
d) spikes up, then goes down.
4 - What are second-grade senior securities? Are the prices steady? Is there a cap on how high their price is? If so, how is that cap determined?
Second-grade senior securities are bonds and preferred stock below that of high-grade senior securities. Their prices are subject to large fluctuations, and they can rise only as high as their maximum price, which is determined by their interest, dividend rate, and call provisions.
5 - What is the central-market value? How do stock prices differ in relation to their CMV in leading issues versus secondary issues?
Central market value is the average of ups and downs in stock’s price. It is generally accurate among leading issues, but secondary issues are usually below CMV.