Equity Markets Flashcards
What is ERP and factors affecting it?
This is the additional return that investors require from equity investment to compensate for the risks relative to risk-free rates of return
Greater risk of default
Lower marketability and liquidity of shares
Higher dealing costs
Greater volatility of returns from shares
Assumptions for dividend discount valuation model
Dividends are reinvested at i
No expenses
The share is held indefinitely
Reasons for different actual equity price and calculated equity price
Models are different
Different assumptions
Different view of the company’s risks
Most other investors are taxed differently
Analyst ignoring other relevant information
Inefficient market
what are preference shares and what are its characteristics
A preference share is a share that when being purchased, the purchaser is prioritized to receive dividends and other benefits before the purchaser of ordinary benefit
More like fixed-interest bonds
Dividend normally a fixed percentage of the par value
Dividend rate is quoted net of tax
Dividends paid only if profits are sufficient
Cumulative if a dividend is unpaid
Prioritized for winding up
Most have no redemption date and no voting rights
Good for companies with high profit volatility
How will equity investor receive returns
dividend
capital growth
Cashflow characteristics of equities
once-off outflow
regular payments of dividends
variable dividends rate since linked to profits
dividends expected to increase
dividends could be held back
can be assumed to continue indefinitely
in case of company failures,shareholder will only be entitled to assets remaining after creditors paid
advantages and disadvantages of industrial groupings
Advantages:
practical for analysts to specialise in one area:
(factors affecting one company are relevant to other companies in the same industry)
(much info will come from a common source)
(specialisation is appropriate for analyse)
(grouping of equities assists in portfolio classification and management)
Share prices of companies in the same sector are likely to be correlated:
(using same resources and similar input costs)
(supply the same market so similarly affected by changes in demand)
(have similar financial structures, so similar changes in interest rates)
Disadvantages:
specialising by industry can mean that analysts miss out on companeis which are between sectores
some shares may not move with their industries or may be influenced by different factors from those analyst is focusing on
it might require a relatively large number of specialists if many sectors are to be covered
not all companies can be easily categorised
How will equities differ between different countries
different drivers of their economies which impact performance of equity markets
may be in different stages of economic cycle so growth differs between sectors
different legislative and regulatory regimes
tax regimes may be different
accounting treatments may be different
political, cultural and social trends would be different
certain industries may be developed or not developed in other countries
risk of currency fluctuations
impact of recession on different types of companies
Cyclical company
share value likely to reduce due to lower expected future dividends and larger require return
Stable/defensive company
share value increase due to little reduction in dividends
little expansion in equity risk premium
lower risk-free rates resulting in a lower required return and lower discount rate
export companies
little/no impact of a local recession
unless the local currency fluctuates significantly
there is a change in the required return
