class 5

Question 1

what is a stock?

Answer 1

a share of ownership in a corporation and gives claim to the corporations earnings and assets

Question 2

what does the value of stocks in the stock market reflect?

Answer 2

both the company’s assets and expectations regarding their future growth

Question 3

what are the 2 things big swings in stock prices affect?

Answer 3

the amount the company raises when issuing additional shares

business investment decisions

Question 4

what do the different classes of stock change?

Answer 4

class A: typically have more voting right
class B: has less voting power

Question 5

what does it mean when a stock is dualistic?

Answer 5

when stocks are listed on different exchanges in different currencies

Question 6

what is a blue chip stock?

Answer 6

large companies that have a long history of paying their dividends and being successful

Question 7

what is the principle way that corporations raise equity capital?

Answer 7

by issuing common stock

Question 8

what do stock holders have the right to?

Answer 8

the right to vote and be the residual claimants of all funds flowing to the firm (receives what ever remains after all other claims against the firms assets have been satisfied)

Question 9

what are dividends?

Answer 9

payments made periodically to the stock holders and are the monetary benefit to the stock holders

Question 10

when are dividends usually paid out?

Answer 10

usually every quarter

Question 11

who sets the price of dividends?

Answer 11

the board of directors

Question 12

what is intrinsic value?

Answer 12

the present value of all its expected future cash flows

Question 13

when valuing stocks, do you valuate them in a portfolio?

Answer 13

no

Question 14

what are the 3 methods of valuing stocks?

Answer 14

dividend discount model

discounted free cash flow model

valuation multiples

Question 15

what is the method of valuing we need to focus on?

Answer 15

dividend discount model

Question 16

what are the 2 cash flows we need to discount in the dividend discount model?

Answer 16

the dividend payments
the price of the future sale of the stock

Question 17

since cash flows are risky, what must we discount them at?

Answer 17

the required return on equity investments

Question 18

what are the 3 ways to estimate growth?

Answer 18

looks at the past
look at what others are estimating
look at fundamentals

Question 19

how can you estimate growth rate by looking at the past?

Answer 19

look at the historical growth in earnings per share is usually a good starting point for growth estimation

Question 20

how can you estimate growth rate by looking at what others are estimating?

Answer 20

analysts estimate growth in EPS for many firms, it is useful to know what their estimates are

Question 21

how can you estimate growth by looking at fundamentals?

Answer 21

ultimately, all growth in earnings can be traced to two fundamentals:
1)how much the firm is investing in new projects
2) what returns these projects are making the firm

Question 22

what are the 2 advantages of the dividend-discount model?

Answer 22

since the dividend-discount model is based on an assets fundamentals, it should be less exposed to market moods and perceptions (should give correct estimated even through investors beliefs)

it forces you to think about the underlying characteristics of the firm and understand its business

Question 23

what are the 3 limitations of the dividend-discount model?

Answer 23

there are tremendous amount of uncertainty associated with forecasting a firms dividend growth rate and future dividends

small changes in the assumed dividend growth can lead to large changes in the estimated stock price

the model doesn’t work for non-dividend or low-dividend paying stocks

Question 24

what companies work best with the dividend-discount model?

Answer 24

stable, high-dividend paying stocks eg coca-cola

Question 25

what does the analysis of stock price evaluation depend on?

Answer 25

peoples expectation of the dividend growth model

Question 26

what are the 2 ways to form an expectation of the dividend growth rate?

Answer 26

adaptive expectation rational expectation

Question 27

what is the adaptive expectation of dividend growth rate?

Answer 27

expectations are formed from past experience only and they change slowly overtime as data changes

Question 28

what is the rational expectation of dividend growth rate?

Answer 28

expectations will be identical to optimal forecasts (best guess about the future) using all available

Question 29

what is an example of adaptive expectation?

Answer 29

if Jeffs average drive to work takes 40 minutes and today it took him 50 minutes, so his expected drive tomorrow would be 45 mins (40+50)/2 based on all prior knowledge

Question 30

what is an example of rational expectation?

Answer 30

if Jeffs average drive is 40 mins, but today it took 50 due to construction, now that the construction is done today making it 4 lanes instead of 2, how expected drive today would be 35 mins due to more lanes

Question 31

are predictions based on rational expectations always accurate?

Answer 31

no, because there can be some relevant information or certain shocks that the predictor is unaware of

Question 32

true or false? "forecasters predictions of inflation are notoriously inaccurate, so their expectations of inflation cannot be rational"?

Answer 32

false, it can be rational but not accurate due to shocks that you did not know when the prediction was made

Question 33

what does the efficient market hypothesis (EMH) state?

Answer 33

it states that prices of securities in financial markets fully reflect all available information

Question 34

what is the efficient market hypothesis?

Answer 34

the application of the theory of rational expectations to financial markets

Question 35

what does the efficient market hypothesis imply regarding the market price of securities?

Answer 35

that securities are normally fairly priced based on their expected cash flows, given all information that is currently available to investors

Question 36

under the efficient market hypothesis, what is the only way that prices would increase or decrease?

Answer 36

only in response to new information, this way investors cannot "beat the market" except through good luck or better information

Question 37

what are the 3 things that efficient market hypothesis says?

Answer 37

investors cannot consistently earn abnormal profit (return) investors choice of portfolio depends on risk tolerance and expected return prices reflect information and price change is driven by (random) arrival of new information

Question 38

what are the 3 things that the efficient market hypothesis does not say?

Answer 38

investors cannot earn profit from investing in stocks investors can throw darts to select stocks prices are random or uncaused

Question 39

what are the 3 forms of efficient market hypothesis?

Answer 39

weak form semi-stromg form strong form

Question 40

what does each form of of efficient market hypothesis depend on?

Answer 40

what information is available

Question 41

what information is available and priced in to the market price for weak form efficient market hypothesis?

Answer 41

just information about past prices and trading volume

Question 42

what information is available and priced in to the market price for semi-strong form efficient market hypothesis?

Answer 42

past prices and trading volume as well as all public information

Question 43

what information is available for strong form efficient market hypothesis?

Answer 43

past prices and trading volumes, all public information as well as all private information

Question 44

what is weak form efficient market hypothesis?

Answer 44

current prices reflect all information about market trading data such as historical prices and trading volume, this investors cannot earn abnormal returns based on past trends

Question 45

in weak form efficient market hypothesis are prices indicators of the historical prices?

Answer 45

yes, all current stock prices have all past prices factored in and all price changes are from unknown information and they follow a random walk

Question 46

what is a random walk?

Answer 46

the moments of a variable whose future values cannot predict (given todays value, the value of the variable is just as likely to fall as it is to rise)

Question 47

what is an important implication of efficient market hypothesis?

Answer 47

stock prices should approximate a random walk and future changes in stock prices should be unpredictable

Question 48

is technical analysis useful if the market is weak form efficient?

Answer 48

no, because looking at past prices won't help because the current price have already factored them in

Question 49

what is technical analysis?

Answer 49

a security analysis technique that claims the ability to forecast the future direction of prices through the study of past market data, primarily prices and volume (charts)

Question 50

what is semi-strong form efficient markets?

Answer 50

an idea that all current prices reflect all relevant pulicaly available information

Question 51

what are the 3 kinds of public information available?

Answer 51

historical price and volume information published accounting statements information found in annual reports

Question 52

is fundamental analysis useful in a semi-strong form efficient market?

Answer 52

no, all the publicly available information that you would analyze is already factored in to the current market price

Question 53

what is fundamental analysis?

Answer 53

research to predict stock value/price that focuses on such determinants as earnings and dividends prospects, expectations for future interest rates

Question 54

what is an example of fundamental analysis?

Answer 54

dividend discount model

Question 55

if the value from fundamental analysis exceeds the current stock price, how would you react?

Answer 55

you should buy the stock

Question 56

why would people use fundamental analysis?

Answer 56

they would use it if they believe the market is not semi-strong form efficient

Question 57

what is strong form efficient market?

Answer 57

when current market prices reflect all publicly and privately available information

Question 58

what does it mean if a market is strong form efficient?

Answer 58

anything pertinent to the stock and known to at least one investor is already incorporated into the securities price

Question 59

do people think the market is strong form efficient?

Answer 59

no most people do not think that

Question 60

does strong form efficient markets incorporate both weak and semi-strong form information and efficiency?

Answer 60

yes

Question 61

do efficient market hypothesis always imply that the market price always reflects the true value of that security?

Answer 61

no, it just says that it gives the best estimate

Question 62

what do some people believe about market prices in efficient market hypothesis?

Answer 62

they believe that market prices are always correct and reflect market fundamentals so that in this sense markets are efficient

Question 63

if people think that the market prices are always correct and reflect market fundamentals and intrinsic value, what would efficiency mean?

Answer 63

efficiency would mean that a stocks price would always reflect its fundamental value or intrinsic value

Question 64

under the assumption that market prices are always correct and reflect the stocks true value, are weak form markets and semi-strong form markets considered efficient?

Answer 64

they would not be

Question 65

true or false, if the market is weak form efficient, it must be semi-strong form efficient?

Answer 65

false

Question 66

if the market is weak form efficient, it can be semi-strong form efficient?

Answer 66

true

Question 67

if the market is semi-strong form efficient, it must be weak form efficient?

Answer 67

true

Question 68

if the market is not weak form efficient, it can be semi-strong form efficient?

Answer 68

false

Question 69

if you can use publicly available information to earn abnormal returns consistently, then the market cannot be weak form efficient?

Answer 69

false

Question 70

if you cannot earn abnormal returns consistently by analyzing historical prices, then fundamental analysis is not useful?

Answer 70

false