Equity prices - Topic A

Question 1

Difference between equities and bonds?

Answer 1

E: Variable promise to pay (dividends), higher risk, on average higher return
B: Fixed promises to pay, lower risk/return

Question 2

Historical economic events that took place that significantly impacted equities?

Answer 2

Dot Com bubble (the early 2000s): stock (related to tech) prices fell to around 78%
GFC (2008): FTSE 100 fell 31%, the biggest recorded annual fall

Question 3

What is the Gordon growth model? Provide assumptions and what is it used for

Answer 3

Share prices = present discounted value (PDV) of future dividends

P = D/(r-g), where P = share price, D = the current dividend per share, r = the required ROR, and g is the expected constant growth rate of dividends

Assumes that expected dividends grow at a constant rate of g per annum + used to compare prices of different equities

Question 4

What causes a rise in share prices?

Answer 4

A fall in the discount rate (required ROR for the shareholder) > lower DR = future dividends/earnings are worth more in today’s $ > makes the stock more valuable today

Fall in real interest rates (5% > 1%)