Lecture 2 Flashcards
What is the most important actor in the financial market?
Consumer. The consumer is the most important actor in any market economy as they buy and consume products, and use surplus income to purchase financial securities.
Define Limited Liability Partnership (LLP).
An LLP is a partnership where partners limit their fractions of concern/business, and each partner’s liability is limited to what they have invested.
It encourages investment by facing a maximum loss of 100% of what they’ve invested.
What is a corporation in financial markets?
A corporation is a legal entity with limited liability, often organized when broader ownership is desired.
It can enter contracts, and its officers are selected by a board of directors. Corporations can be publicly traded or privately held.
What is a crown corporation?
In Canada, a crown corporation is government-owned but may be set up to offer a service beyond maximizing profitability (e.g., Canada Post). It can sometimes go public, as in the case of Atomic Energy Canada Limited.
Explain the role of banks in financial markets.
Banks operate in capital markets and might grow into investment banks (IB).
They handle a variety of financial services, including managing funds through investment firms.
What are regulators, and give an example.
Regulators ensure the fairness and integrity of the financial markets.
An example includes the Ontario Securities Commission (OSC) and the Securities Exchange Commission (SEC) which oversee market operations.
What is the NPV method used for in finance?
The NPV (Net Present Value) method is used for valuing various investments or projects by discounting their expected cash flows to present value.
Define assets in the context of finance.
Assets are resources owned by a business or individual that are expected to bring future economic benefits.
Historically, assets included physical items like gold, silver, and IOUs, but now they largely consist of contractual assets like stocks and bonds.
What are stocks?
Stocks are financial securities that represent a share of ownership in a company.
They offer the holder a portion of the company’s profits and are typically bought and sold on stock exchanges.
What are bonds?
Bonds are financial instruments that represent a loan made by an investor to a borrower (typically corporate or governmental).
They bind the issuer to pay back the principal along with interest at a predetermined schedule.
What does it mean when an asset is described as “transferable” and “immaterial”?
Assets that are transferable and immaterial can be freely bought and sold without physical exchange, often existing mainly as entries in electronic records or legal documents, rather than as physical items.
Give examples of ancient and modern forms of assets.
Ancient assets included gold, silver coins, and IOUs, while modern assets include stocks and bonds, which are often purely contractual and stored electronically.
What happens to profits retained by a company?
Profits retained by a company are channeled into Retained Earnings on the balance sheet, which increases the value of the firm and thus the share price.
What is a dividend in the context of stock investments?
A dividend is a distribution of a portion of a company’s earnings to its shareholders as decided by the board of directors.
Explain the difference between common shares and preferred shares.
Common shares typically confer one vote per share and might receive dividends variably.
Preferred shares often provide no or limited voting rights but offer more stable dividends and higher priority during bankruptcy liquidation.
What is a treasury share?
Treasury shares are stock that a company has bought back from shareholders.
They do not affect the company’s value like slicing a pizza into fewer slices, each representing the same total pizza.
What is an IPO?
An IPO (Initial Public Offering) is when a company first offers its shares to the public, facilitated by a syndicate of financial intermediaries.
What happens when a company goes insolvent?
If a company becomes insolvent and files for bankruptcy, it must settle all liabilities before shareholders can receive any residual value, making shareholders lower priority compared to debt holders.
What is the Discounted Cash Flow (DCF) method?
The DCF method is a valuation technique used to estimate the value of an investment based on its expected future cash flows, adjusted for the time value of money.
What does the growing perpetuity formula in stock valuation look like?
The growing perpetuity formula for valuing a stock is given by: PV = D1 / (r - g), where D1 is the dividend expected next period, r is the required rate of return, and g is the growth rate of dividends.
Calculate the price of a stock expected to pay a $5 dividend next year that grows at 3% annually with an 11% required return.
Using the formula PV = D1 / (r - g),
substitute D1 = $5, r = 0.11, and g = 0.03:
PV = $5 / (0.11 - 0.03) = $62.50 (Note: slight discrepancy due to rounding in the original calculation).
What is the Discounted Dividend Model (DDM)?
The DDM is a method used to estimate the value of a stock by discounting expected dividends to their present value.
It assumes dividends will grow at a constant rate indefinitely.
How to calculate the value of growth opportunities for a stock?
The value of growth opportunities can be calculated as the difference between the stock price including growth and the price as a constant perpetuity.
For example, if the stock price with growth is $64.31 and without growth is $45.46, the value of growth opportunities is $64.31 - $45.46 = $18.85.
What happens to the stock price in a zero growth scenario according to DDM?
In a zero growth scenario, where g = 0%, the stock price can be calculated as PV = D0 / r. If D0 = $5 and r = 0.11, then PV = $5 / 0.11 = $45.45.