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Financial Economics Year 3 > 4. Equity Valuations > Flashcards

4. Equity Valuations Flashcards

1
Q

What does Pn stand for in the Generalised Dividend Valuation Model?

A
  • (Expected) sale price of the stock at time N.
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2
Q

What does Dt stand for in the Generalised Dividend Valuation Model?

A

(Expected) dividend paid at time t

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3
Q

What does ke stand for in the Generalised Dividend Valuation Model?

A

Required return on the equity

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4
Q

How is price of stock determined?

A

As the net present value of the future dividend stream.

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5
Q

What do we assume in the Gordon Growth Model?

A

Assume dividends are growing with a constant rate where g is less that Ke^t < (required rate of return)

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6
Q

What does D0 stand for in the Gordon Growth Model

A

Denotes the most recent dividend paid.

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7
Q

What does g stand for in the Gordon Growth Gordon model?

A
  • Myron J. Gordon is the founder
  • Constant growth rate
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8
Q

What are the challenges with the Gordon Growth Model?

A
  • Dividend stream e.g. growth rates, other related measures - consider P/E ratio with the payout rate n such that nEt = Dt, in general
  • Required return: starting with CAPM.
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9
Q

What Does P/E stand for?

A

Price to Earnings

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10
Q

What does E (ri) stand for in the Capital Asset Pricing Model (CAPM)?

A

Expected return of the asset i.

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11
Q

What does Rf stand for in the CAPM?

A
  • Risk free return.
  • Value of time.
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12
Q

What does E(rm) stand for in the CAPM?

A

Expected return on the market portfolio m

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13
Q

What does beta stand for in the CAPM?

A
  • Sensitivity of asset i’s return to the market return.
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14
Q

Capital Asset Pricing Model

A

E(ri) = rf + Beta(i)[E(rm) - rf]

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15
Q

Beta and Security Market Line

A

Check notebook.

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16
Q

What is the security market line?

A
  • Expected return of the stocks is a (linear) function of their beta with the market.
17
Q

What does it mean if beta is 1.5?

A
  • For every 1% increase in the market excess return, stock I’d return is expected to increase by 1.5% ceteris paribus.
18
Q

Mean Variance analysis on portfolio selection problem

A

Assumes that the expected return and risk of a portfolio are measured respectively by the mean and variance (or standard deviation) of the portfolios return.

19
Q

How can risk of a portfolio be reduced?

A
  • By adding more assets.
20
Q

What’s the efficient frontier?

A

Feasible portfolios with highest possible expected return and lowest level of volatility.

21
Q

Two-Fund Separation Theorem

A

By introducing a risk-free asset, investors choose their optimal portfolio to combine the risk-free asset with an efficient risky portfolio.

22
Q

Capital Market Line

A

Under CAPM, all investors optimally would hold some combination of the risk free security and the market (efficient) portfolio.

23
Q

CAPM Restrictive Assumptions

A
  • Investors choose portfolio based on the mean and variance of returns.
  • Investors are rational and risk averse.
  • Investors all invest for the same period of time.
  • Investors have homogenous expectations.
  • Investors can have unlimited short-sale positions on the risk-free assets.
  • Markets are competitive and frictionless.
24
Q

What does a share of a common stock allow stockholders to do?

A
  • Receive dividends
  • Vote
25
Q

Value of Any Investment

A

Present value of all future net cash floes generated by the investment.

26
Q

In GDVM, what does a stock’s value depend on?

A
  • It’s future dividend payments and the required return on equity.
27
Q

Elements of Gordon Growth Model?

A
  • The expected constant growth of dividends (g)
  • Stock’s most recent dividend paid.
  • Required return on investments in equity.
28
Q

Examples of Systematic Risk

A
  • Risk that FED raises interest rates.
  • Risk that oil prices rise, increasing production costs.
  • Risk that economy slows, reducing demand for firm products.
29
Q

What will happen to the volatility in a large portfolio?

A

Will decline as the size of the portfolio increases only the systematic risk remains.

30
Q

How is risk premium of a security determined?

A
  • By its systematic risk and does not depend on it diversifiable risk.
31
Q

What happens when stocks are combined in a large portfolio?

A
  • The firm-specific risks for each stock will average out and will be diversified.
32
Q

Investors holding risky securities

A

Same proportion as the efficient portfolio, their combined portfolio will also reflect the same proportions as the efficient portfolio.

33
Q

How is a portfolio risk premium and volatility determined?

A
  • By the fraction that is invested in the market.

Financial Economics Year 3 (9 decks)

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