Essential Trading Terms and Financial Market Concepts
Core Market Terminology
- Spot Price: The current market price at which an asset (stock, currency, commodity) can be bought or sold for immediate delivery/settlement. Also called the “cash price.”
- Bid Price: The highest price a buyer is willing to pay for a security at a given moment.
- Ask Price (Offer Price): The lowest price a seller is willing to accept for a security. Bid-Ask Spread = Ask − Bid.
- Lot Size: The minimum number of units/shares in one futures or options contract. In India, lot size is
Financial Markets, Intermediaries, and Fixed Income Assets
Markets, Intermediaries & Financing Instruments
Money Markets vs. Capital Markets
| Feature | Money Market | Capital Market |
|---|---|---|
| Maturity | < 1 year | > 1 year |
| Instruments | Promissory notes, treasury bills, credit lines, commercial discounts | Bonds, stocks, fixed-term loans |
| Purpose | Finance working capital | Finance fixed asset investments & expansion |
| Liquidity | High | Lower |
| Credit Risk | Relatively low | Higher |
The 3 Channels of Market Operation
- Organised institutions: NYSE, regional exchanges, regulated markets
- OTC market: Brokers
Capital Budgeting and Bond Valuation Formulas
Capital Budgeting Metrics
- NPV: NPV = -C₀ + CF₁/(1+r)¹ + CF₂/(1+r)² + … + CFₙ/(1+r)ⁿ. Accept if NPV > 0.
- IRR: The discount rate where NPV = 0. Accept if IRR > r.
- Payback: Years to recover initial investment. Discounted Payback uses discounted cash flows.
- PI: PI = PV(future CFs) / Initial Investment. Accept if PI > 1.
- MIRR: Solves PV(outflows) × (1+MIRR)ⁿ = FV(inflows).
Decision Rules and Conflicts
- NPV vs IRR: Use NPV for mutually exclusive projects or differences in scale/timing.
Financial Decision Making and Capital Optimization
Capital Structure and Share Valuation
First, I check the shares mentioned.
| Debt Ratio | Asset | Debt | Equity | NS Shares |
|---|---|---|---|---|
| % Provided | $ Finance Your Company | Ratio x Asset | Asset – Debt | Equity / Shares |
Earnings and Return Metrics
| Interest | Interest Expense | EPS | Expected EPS | Expected Return |
|---|---|---|---|---|
% Provided. Examples:
| Interest x Debt | NPAT / N Shares | Same as EPS | % Provided |
Risk and Variance Calculations
| Price per Share | Standard Deviation | Coefficient of Variation |
|---|---|---|
| EPS / Expected Return | EPS |
Understanding Put-Call Parity and Derivatives Markets
Put–Call Parity
This model states that for a given call price, the corresponding put price for the same exercise price and tenure can be determined. This is known as the Put–Call Parity rule.
Consider two portfolios:
- First Portfolio: Stock + Put
- Second Portfolio: Call + Present Value of Strike Price
At expiry, the value of both portfolios will be equal under all conditions.
Analysis at Expiry
Case 1: Stock Price < Exercise Price (e.g., 80 < 100)
- Portfolio A (Stock + Put): Stock price at end +
Financial Valuation Methods: DDM, P/E, and DCF Analysis
Two-Stage Dividend Discount Model (DDM)
PQW will pay an annual dividend of 0.65 one year from now. Analysts expect this dividend to grow at 12% per year until the fifth year. After the fifth year, the growth rate will be 2% per year forever. If the firm’s equity cost of capital is 8%, what is the value of a share of PQW stock using the dividend discount model?
Given Data
- D1 = 0.65
- g1 (Years 1–5) = 12%
- g2 (after Year 5) = 2%
- r = 8%
Step 1: Calculate Dividends for Years 1–5
- D1 = 0.65
- D2 = 0.65(1.12)