Finance Week 6 Flashcards
What is the equity market?
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.
What are stocks used for?
Used by corporations to raise money for long term investments
What does issuer of new shares receive?
Receives proceeds from selling shares to investors.
What do investors in the stock market receive?
Part ownership of the firm
What is the primary market?
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.
What is the secondary market?
Where existing shares are bought and sold by investors. Main: NYSE and Nasdaq
What do you receive as an owner of shares of a firms equity?
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.
How can corporation raise money?
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.
What are the earnings per share?
profit / share
What is the price earnings ratio?
Price / earnings
What is the dividend yield?
Dividends / price
What is the market cap?
Price * # shares
What is stock valuation?
stock valuation are calculations by investors to see what their expected returns are for a stock.
What is a stocks value?
It is the PV of all future dividend using interest rate r
Why do far-distant dividends have small impact on stock’s value?
The PV of far dividend is very small
Why is valuing a stock difficult?
Dividend forecast has to take into account: competition, suppliers, employee culture, mega-trends, management integrity, legal issues, cyber issues
What is SV by comparables?
Valuing stocks by taking similar companies and seeing what investors are willing to pay on average for each dollar/earnings
What is the PE ratio?
What investors are willing to pay on average for each dollar of earnings for similar companies
Why is valuing a stock important?
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
What is a firms intrinsic value?
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
What is the dividend cost model and what are the types?
Dividend cost model are 3 different models used to value stocks: No growth stocks, constant growth stocks and non constant growth stocks
What is the no-growth model?
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
What is the constant growth model?
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.
What is the non-constant growth model?
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.
How do you find the stocks value in H years?
What is the Vh? Calculate with constant-growth dividend discount model: Vh = Div (h+1) / (r - g)
What is the relationship between the price and intrinsic value of a stock in an efficiently working capital market?
A firms stock price is equal to the intrinsic value.
Why is a firms stock price equal to intrinsic value in an efficient market?
Because investors try find undervalued stocks, when they do they buy and its price up
What is arbitrage trading?
It is the process of actively valuing and buying stocks that are below their intrinsic value
What is the expected stock return in a year if the expected dividends and expected price increase is given?
return = (Div1 + (P1-P0))/P0
The Div1/P0 part is the dividend yield. The (P1-P0)/P0 is the capital gain or loss part
What is the price of a share?
PE*EPS
What is the value of a company?
(Average PE of similar companies) * EPS
What is the value of a stock if investor buys a stock today and plants to sell in 1 year after collecting dividends?
V0 = Div1 + P1 / (1 + r) Value of the stock today is the PV of the price in and dividends in 1 year
What is the PV of stock today also called?
Intrinsic value
What is the discount factor?
This is 1/ (1+r)^t
If a firm is paying its first dividend in 5 years what do you do?
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
If finding value of stock in year 5 what dividend do you use?
Div6
Price of share
= PE ratio * earnings per share
If company pays dividends tomorrow what do you do?
Find PV of stock normally but add the dividends to final answer
