EOC Qs, Reading 12

Question #15.

Which flow of funds indicator is considered bearish for equities:

a) Increase in IPOs

b) High cash in MF

c) more volume in declining shares.

I would think that correct answer is B, however CFAI thinks its A.

I dont get it, this is counterintuitive, and gets me every time. When we are bearish, we keep cash or buy cash equivalents, thus we sit high in cash. Unless I understand the logic why A is correct, I’ll keep getting this wrong everytime.

Thank you!

At a point in time where mutual funds have a lot of cash on hand, they are going to start buying equities to reduce the amount of cash, and the market will turn around.

I think the trick with this question is to use these indicators as a tool to forecast what will happen in the future, rather than reflecting the current situation.

High cash in MF means the MF will eventually re-enter the market and increase volumes/prices (bullish indicator)

More volume in declining shares indicates downward trend - not sure if this is a “flow of funds” indicator.

Increase in ipos indicates we’re at the top end of the market (ipos are not usually undertaken unless the market is favourable. If conditions are not, the company would go for a trade sale/debt/ private equity injection etc.). To ipo would mean you’re already at “peak” conditions, therefore predicting bearing conditions going forward.

I think the reason for A is that increase in IPOs will urge people to invest in IPOs and it would be bearish for securities which are already trading in the market.

I dont really understand what you are trying to say here but the main reason is IPO increase is a bearish sign because companies filing for IPOs do it when the market prices at high preniums which means that the market is overvalued which is a bearish sign (less upside potential and downward correction is very likely). MF cash if high means they eventually gonna enter the market and make prices rise so its bullish.