Equity Investments

Question 1

Efficient Market Hypothesis

Answer 1

Changes in stock returns for individual stocks and portfolios are unpredictable. Hence, it is impossible on average to outperform the market portfolio by using active stock picking.

Question 2

Risk Free rate

Answer 2

rf : rate of return which can be earned with certainty

Question 3

Risk Premium (excess return)

Answer 3

ERp - rf : return in excess of risk free rate

ERp - rf = Const * A * σp^2

Question 4

Intrinsic Value of Equity

Answer 4

Present value of all future cash payments (CF = Div + P, Future dividends and sale of stocks)

Question 5

Market Price of Equity

Answer 5

Price currently paid for the share

Question 6

Equity pricing model

Answer 6

V0 = Div1 / (1+k) + Div2 / (1+k)^2 +…+ (Divn + Pn)/(1+k)^n

Question 7

Dividend Discount Model

Answer 7

Stock Price should be equal to PV (all future dividends)

Vt = Div t+1/(k-g)

• Constant Dividends
  V0 = DIV / k
  D/P = k (constant)
• Constant growth of dividends
  V0 = Div1/(k-g)
  Div1 = Div0(1+g), Div2 = Div1(1+g)
  D/P = k-g (constant)