EXAM 2 Flashcards
Value of Preferred Stock FORMULA
Gordon Growth Model FORMULA
to find the value of a share of stock today using the two-stage model, do the following 6 steps
- Forecast the dividend cash flows for the supernormal period year by year.
- Discount the supernormal dividends back to the present at the required rate of return.
- Find the first normal growth dividend.
- Use the Gordon model to find the value of the cash flows from the end of the high-growth period through infinity.
- Discount the Gordon model result back to the present (remembering to place it in the appropriate time period).
- Add together the values from steps 2 and 5.
For purposes of the Gordon model, dividends that are “recently paid,” “currently being paid,” or “paid today” all refer to time ___dividends, or ___, not ___
0, D0, D1
For purposes of the Gordon model, dividends that are “___,” “___,” or “___” all refer to time 0 dividends, or D0, not D1
recently paid, currently being paid, paid today
discounted rate of return FORMULA
D1 =
D0 (1 + g)
expected growth rate FORMULA
PV OF RETURN REQUIRED
A firm just issued new shares of preferred stock that will pay a dividend of $4.60. If the return required by shareholders is 10%, then the price of the preferred stock is ____________.
“The value of all future cash flows for a project beyond the forecasted period.”
“Terminal Value”
“Securities that provide investors with a rate of return determined by market forces and management discretion.”
“Variable-return Securities”
“The right of a stockholder to the earnings and assets of company after the company has paid all prior obligations.”
“Residual Claim”
“A wealthy investor who meets actual net worth and income qualifications set by the SEC and is given special status conferring additional investment opportunities.”
“Accredited Investors”
2 ASSUMPTIONS OF “Gordon Growth Model”
- dividends are paid every year
- grow at a constant rate forever
“A category of financial models that include multiple stages as necessary to correctly model a company’s expected future growth.”
“Multistage Growth Models”
GORDON GROWTH MODEL AKA
“Constant Dividend Growth Model”
“The rate of return expected for a real estate property; the denominator of the Gordon growth model, k-g.”
“Capitalization Rate”
required/expected RATE OF RETURN FORMULA
PRICE OF STOCK FORMULA
Holding Period Return Model PRICE FORMULA
Holding Period Return Model PRICE FORMULA
Holding Period Return Model PRICE FORMULA
Annualized Return FORMULA
Expected Return formula
Standard deviation formula
“A line that expresses required return as a function of the risk-free rate and a risk premium determined by beta.”
“Security Market Line (SML)”
“The hypothesized or “best-guess” estimate of future prices or returns under different scenarios.”
“Expectational Data”
“The hypothesized or “best-guess” estimate of future prices or returns under different scenarios.”
“Expectational Data”
“Risk that is inherent in the economy as a whole and cannot be diversified away; also called systematic risk or nondiversifiable risk.”
“Market Risk”
“Risk that is inherent in the economy as a whole and cannot be diversified away; also called systematic risk or nondiversifiable risk.”
“Market Risk”
“Risk that results from factors at a particular firm and can be reduced through diversification; also called nonsystematic risk or idiosyncratic risk.”
“Firm-specific Risk”
“Risk that results from factors at a particular firm and can be reduced through diversification; also called firm-specific risk or idiosyncratic risk.”
“Nonsystematic Risk”
“The notion that the size of the risk premium is based on market risk.”
“Systematic Risk Principle”
“Systematic Risk Principle”
“The notion that the size of the risk premium is based on market risk.”
“Risk that is inherent in the economy as a whole and cannot be diversified away; also called market risk or systematic risk.”
“Nondiversifiable Risk”
“A technique to estimate the cost of equity.”
“Build-up Method”
“The rate of return on an investment with no risk.”
“Risk-free Rate”
“The minimum return an investor requires to invest in an asset given the investment’s risk; another name for discount rate and return on equity.”
“Required Rate of Return”
“The process of spreading risk across multiple assets. Decreasing risk by combining assets that are not perfectly correlated, thus spreading the risk out.”
“Diversification”
“The compensation for the amount of risk taken on by investors.”
“Risk Premium”
“Firm-specific risk or the portion of risk that is diversifiable. Another name for unsystematic risk.”
“Idiosyncratic Risk”
“The possibility that the realized or actual return will differ from the expected return.”
“Risk”
“Risk that results from factors at a particular firm and can be reduced through diversification; also called firm-specific risk or nonsystematic risk.”
“Idiosyncratic Risk”
“Risk that results from factors at a particular firm and can be reduced through diversification; also called firm-specific risk or nonsystematic risk.”
“Idiosyncratic Risk”
“The process of “spreading” one’s money over many different assets.”
“The notion that the size of the risk premium is based on market risk.”
“Systematic Risk Principle”
“The money gained or lost on an investment over a certain period of time.”
“Return”
“Companies or securities with betas less than 1.”
“Defensive Assets”
“A measure used as an approximation for something else.”
“Proxy”
“Companies or securities with betas greater than 1.”
“Aggressive Assets”
“A measure of systematic risk determined by a regression line.”
“Beta”
“Risk that is inherent in the economy as a whole and cannot be diversified away; also called market risk or nondiversifiable risk.”
“Systematic Risk”
“Past prices and cash flows that are used to estimate returns.”
“Historical Data”
“A measure of total dispersion of possible outcomes about the mean; used to measure total risk.”
“Standard Deviation”
“The return over the entire period that an investor owns a financial security.”
“Holding Period Return (HPR)”
“A linear model used to determine the risk-return relationship for an asset.”
“Capital Asset Pricing Model (CAPM)”
“How related one asset’s returns are to another asset’s returns.”
“Correlation”
REQUIRED RETURN =
RISK FREE RATE OF RETURN
COVARIANCE OF RETURNS
WHAT IS THE CORRELATION COEFFICIENT OF RETURNS BETWEEN STOCKS A AND B
EXPECTED RETURN OF A PORTFOLIO
EXPECTED RETURN, BETA, STANDARD DEVIATION OF A PORTFOLIO
