Finance Week 6

Question 1

What is the equity market?

Answer 1

Corporations can issue new shares of equity and sell them to investors on the equity market. it is the biggest market where new shares are issued, bought and sold.

Question 2

What are stocks used for?

Answer 2

Used by corporations to raise money for long term investments

Question 3

What does issuer of new shares receive?

Answer 3

Receives proceeds from selling shares to investors.

Question 4

What do investors in the stock market receive?

Answer 4

Part ownership of the firm

Question 5

What is the primary market?

Answer 5

This is where new shares are issued. An IPO is when shares issued for the first time and this is done in the primary market.

Question 6

What is the secondary market?

Answer 6

Where existing shares are bought and sold by investors. Main: NYSE and Nasdaq

Question 7

What do you receive as an owner of shares of a firms equity?

Answer 7

You become a part owner and receive periodic dividend and have residual claim on the firms assets after all obligations are fulfilled for that firm. These both depend on firms performance.

Question 8

How can corporation raise money?

Answer 8

Corporation can raise money for long term by issuing bonds or stock
If the corporation issues new bonds, firm receives proceeds from selling new bonds to investors on the bond market- in return firm commits to make coupon payments + return face value. If the corporation issues new stock, firm receives proceeds from selling new shares to investors on the equity market- in return the firm makes new shareholders part-owners that receive dividends and that have a residual claim on the firms assets after all liabilities are met.

Question 9

What are the earnings per share?

Answer 9

profit / share

Question 10

What is the price earnings ratio?

Answer 10

Price / earnings

Question 11

What is the dividend yield?

Answer 11

Dividends / price

Question 12

What is the market cap?

Answer 12

Price * # shares

Question 13

What is stock valuation?

Answer 13

stock valuation are calculations by investors to see what their expected returns are for a stock.

Question 14

What is a stocks value?

Answer 14

It is the PV of all future dividend using interest rate r

Question 15

Why do far-distant dividends have small impact on stock’s value?

Answer 15

The PV of far dividend is very small

Question 16

Why is valuing a stock difficult?

Answer 16

Dividend forecast has to take into account: competition, suppliers, employee culture, mega-trends, management integrity, legal issues, cyber issues

Question 17

What is SV by comparables?

Answer 17

Valuing stocks by taking similar companies and seeing what investors are willing to pay on average for each dollar/earnings

Question 18

What is the PE ratio?

Answer 18

What investors are willing to pay on average for each dollar of earnings for similar companies

Question 19

Why is valuing a stock important?

Answer 19

Need to know what price to sell at IPO, FM need to assess value of a project before investing, want to know value of a stock before investing

Question 20

What is a firms intrinsic value?

Answer 20

Book equity value that a firm calculates is according to GAAP. not a good measure. Firms intrinsic value is the sum of discounted future dividend (forward looking). Firms intrinsic value includes internally created intangible assets

Question 21

What is the dividend cost model and what are the types?

Answer 21

Dividend cost model are 3 different models used to value stocks: No growth stocks, constant growth stocks and non constant growth stocks

Question 22

What is the no-growth model?

Answer 22

This is used to forecast stocks whose dividends is not growing, stock paying same dividend every year forever. Stock is a perpetuity and is calculated as: Vo = Div 1 / r. This is used for water/utility companies- not expected to grow

Question 23

What is the constant growth model?

Answer 23

The constant growth dividend discount model: is Vo = Div 1 / r - g. This is where r is annual discount rate, g is rate at which dividends grows. model requires that r > g.

Question 24

What is the non-constant growth model?

Answer 24

This model is where stocks dividends are growing irregularly for H years then settle at constant rate. The stocks value is the PV of the individual dividends + PV of stocks future value with constant dividends. V0=Div1/(1+r)+….+(1/(1+r)^H) * (Vh). So it is the PV of all irregular dividends, + PV of stocks value in H years when starts paying dividends with constant dividend growth.

Question 25

How do you find the stocks value in H years?

Answer 25

What is the Vh? Calculate with constant-growth dividend discount model: Vh = Div (h+1) / (r - g)

Question 26

What is the relationship between the price and intrinsic value of a stock in an efficiently working capital market?

Answer 26

A firms stock price is equal to the intrinsic value.

Question 27

Why is a firms stock price equal to intrinsic value in an efficient market?

Answer 27

Because investors try find undervalued stocks, when they do they buy and its price up

Question 28

What is arbitrage trading?

Answer 28

It is the process of actively valuing and buying stocks that are below their intrinsic value

Question 29

What is the expected stock return in a year if the expected dividends and expected price increase is given?

Answer 29

return = (Div1 + (P1-P0))/P0

The Div1/P0 part is the dividend yield. The (P1-P0)/P0 is the capital gain or loss part

Question 30

What is the price of a share?

Answer 30

PE*EPS

Question 31

What is the value of a company?

Answer 31

(Average PE of similar companies) * EPS

Question 32

What is the value of a stock if investor buys a stock today and plants to sell in 1 year after collecting dividends?

Answer 32

V0 = Div1 + P1 / (1 + r) Value of the stock today is the PV of the price in and dividends in 1 year

Question 33

What is the PV of stock today also called?

Answer 33

Intrinsic value

Question 34

What is the discount factor?

Answer 34

This is 1/ (1+r)^t

Question 35

If a firm is paying its first dividend in 5 years what do you do?

Answer 35

Use dividend discount model for constant growth to find V5 (value of share in year 5) so this involved D6 (6th dividend) then find the PV of this value

Question 36

If finding value of stock in year 5 what dividend do you use?

Answer 36

Div6

Question 37

Price of share

Answer 37

= PE ratio * earnings per share

Question 38

If company pays dividends tomorrow what do you do?

Answer 38

Find PV of stock normally but add the dividends to final answer