class 5 Flashcards
what is a stock?
a share of ownership in a corporation and gives claim to the corporations earnings and assets
what does the value of stocks in the stock market reflect?
both the company’s assets and expectations regarding their future growth
what are the 2 things big swings in stock prices affect?
the amount the company raises when issuing additional shares
business investment decisions
what do the different classes of stock change?
class A: typically have more voting right
class B: has less voting power
what does it mean when a stock is dualistic?
when stocks are listed on different exchanges in different currencies
what is a blue chip stock?
large companies that have a long history of paying their dividends and being successful
what is the principle way that corporations raise equity capital?
by issuing common stock
what do stock holders have the right to?
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)
what are dividends?
payments made periodically to the stock holders and are the monetary benefit to the stock holders
when are dividends usually paid out?
usually every quarter
who sets the price of dividends?
the board of directors
what is intrinsic value?
the present value of all its expected future cash flows
when valuing stocks, do you valuate them in a portfolio?
no
what are the 3 methods of valuing stocks?
dividend discount model
discounted free cash flow model
valuation multiples
what is the method of valuing we need to focus on?
dividend discount model
what are the 2 cash flows we need to discount in the dividend discount model?
the dividend payments
the price of the future sale of the stock
since cash flows are risky, what must we discount them at?
the required return on equity investments
what are the 3 ways to estimate growth?
looks at the past
look at what others are estimating
look at fundamentals
how can you estimate growth rate by looking at the past?
look at the historical growth in earnings per share is usually a good starting point for growth estimation
how can you estimate growth rate by looking at what others are estimating?
analysts estimate growth in EPS for many firms, it is useful to know what their estimates are
how can you estimate growth by looking at fundamentals?
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
what are the 2 advantages of the dividend-discount model?
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
what are the 3 limitations of the dividend-discount model?
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
what companies work best with the dividend-discount model?
stable, high-dividend paying stocks eg coca-cola
what does the analysis of stock price evaluation depend on?
peoples expectation of the dividend growth model
what are the 2 ways to form an expectation of the dividend growth rate?
adaptive expectation
rational expectation
what is the adaptive expectation of dividend growth rate?
expectations are formed from past experience only and they change slowly overtime as data changes
what is the rational expectation of dividend growth rate?
expectations will be identical to optimal forecasts (best guess about the future) using all available
what is an example of adaptive expectation?
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
what is an example of rational expectation?
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
are predictions based on rational expectations always accurate?
no, because there can be some relevant information or certain shocks that the predictor is unaware of
true or false? “forecasters predictions of inflation are notoriously inaccurate, so their expectations of inflation cannot be rational”?
false, it can be rational but not accurate due to shocks that you did not know when the prediction was made
what does the efficient market hypothesis (EMH) state?
it states that prices of securities in financial markets fully reflect all available information
what is the efficient market hypothesis?
the application of the theory of rational expectations to financial markets
what does the efficient market hypothesis imply regarding the market price of securities?
that securities are normally fairly priced based on their expected cash flows, given all information that is currently available to investors
under the efficient market hypothesis, what is the only way that prices would increase or decrease?
only in response to new information, this way investors cannot “beat the market” except through good luck or better information
what are the 3 things that efficient market hypothesis says?
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
what are the 3 things that the efficient market hypothesis does not say?
investors cannot earn profit from investing in stocks
investors can throw darts to select stocks
prices are random or uncaused
what are the 3 forms of efficient market hypothesis?
weak form
semi-stromg form
strong form
what does each form of of efficient market hypothesis depend on?
what information is available
what information is available and priced in to the market price for weak form efficient market hypothesis?
just information about past prices and trading volume
what information is available and priced in to the market price for semi-strong form efficient market hypothesis?
past prices and trading volume as well as all public information
what information is available for strong form efficient market hypothesis?
past prices and trading volumes, all public information as well as all private information
what is weak form efficient market hypothesis?
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
in weak form efficient market hypothesis are prices indicators of the historical prices?
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
what is a random walk?
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)
what is an important implication of efficient market hypothesis?
stock prices should approximate a random walk and future changes in stock prices should be unpredictable
is technical analysis useful if the market is weak form efficient?
no, because looking at past prices won’t help because the current price have already factored them in
what is technical analysis?
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)
what is semi-strong form efficient markets?
an idea that all current prices reflect all relevant pulicaly available information
what are the 3 kinds of public information available?
historical price and volume information
published accounting statements
information found in annual reports
is fundamental analysis useful in a semi-strong form efficient market?
no, all the publicly available information that you would analyze is already factored in to the current market price
what is fundamental analysis?
research to predict stock value/price that focuses on such determinants as earnings and dividends prospects, expectations for future interest rates
what is an example of fundamental analysis?
dividend discount model
if the value from fundamental analysis exceeds the current stock price, how would you react?
you should buy the stock
why would people use fundamental analysis?
they would use it if they believe the market is not semi-strong form efficient
what is strong form efficient market?
when current market prices reflect all publicly and privately available information
what does it mean if a market is strong form efficient?
anything pertinent to the stock and known to at least one investor is already incorporated into the securities price
do people think the market is strong form efficient?
no most people do not think that
does strong form efficient markets incorporate both weak and semi-strong form information and efficiency?
yes
do efficient market hypothesis always imply that the market price always reflects the true value of that security?
no, it just says that it gives the best estimate
what do some people believe about market prices in efficient market hypothesis?
they believe that market prices are always correct and reflect market fundamentals so that in this sense markets are efficient
if people think that the market prices are always correct and reflect market fundamentals and intrinsic value, what would efficiency mean?
efficiency would mean that a stocks price would always reflect its fundamental value or intrinsic value
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?
they would not be
true or false, if the market is weak form efficient, it must be semi-strong form efficient?
false
if the market is weak form efficient, it can be semi-strong form efficient?
true
if the market is semi-strong form efficient, it must be weak form efficient?
true
if the market is not weak form efficient, it can be semi-strong form efficient?
false
if you can use publicly available information to earn abnormal returns consistently, then the market cannot be weak form efficient?
false
if you cannot earn abnormal returns consistently by analyzing historical prices, then fundamental analysis is not useful?
false
