Chapter 7 Flashcards
What is a common stock?
the principal medium through which corporations raise equity capital
Stockholders are?
those who hold stock in a corporation - own an interest in the corporation equal to the percentage of outstanding shares they own.
To be a residual claimant?
stockholders receives whatever remains after all other claims against the firm’s assets have been satisfied
Dividends?
payments made periodically, usually every quarter to stockholders.
What assumptions make the Gordon Growth Model useful for finding the value of a stock?
- Dividends are assumed to continue growing at a constant rate forever
- The growth rate is assumed to he less than the required return on equity, ke
Adaptive expectations?
suggests that changes in expectations will occur slowly over time, as data for a variable evolve.
How are adaptive expectations faulted?
On the grounds that people use more info than just past data on a single variable to form their expectations of that variable.
Theory of rational expectations?
Expectations will be identical to optimal forecasts using all available information.
Why may an expectation fail to be rational?
- People might be aware of all available information but find it takes too much effort to make their effort to make their expectation the best guess possible.
- People might be unaware of some available relevant information, so their best guess of the future will not be accurate.
Implications of Rational Expectations Theory?
- if there is a change in the way a variable moves, that way in which expectations of this variable are formed will change as well
- the forecast errors of expectations will, on average, be zero and cannot be predicted ahead of time.
Efficient market hypothesis?
Based on the assumption that prices of securities in financial markets fully reflect all available information.
What does the equation Rof = R* (optimal forecast return = equilibrium return) tell us?
current prices in a financial market will be set so that the optimal forecast of a security’s return using all available information equals the security’s equilibrium return.
the efficient market condition?
In an efficient market, all unexploited profit opportunities will be eliminated. An extremely important factor in the reasoning is that not everyone in a financial market must be well informed about a security or have rational expectations for its price to be driven to the point at which the efficient market condition holds.
What is the random walk behaviour of stock prices?
Describes the movements of a variable whose future values cannot be predicted because, given today’s value, the value of the variable is just as likely to fall as it is to rise.
an important implication - future changes in stock prices should, for all practical purposes, be unpredictable
behavioural finance?
applies concepts from other social sciences, such as anthropology, sociology and particularly psychology to explain behaviour of securities prices.
