Stock Market Flashcards
What are the rights of a Stockholder?
- Right to vote
- Residual claimant of cash-flow
- Receives dividends
What models are used to compute the price of a stock?
1) One-period valuation model
2) Generalized dividend valuation m.
3) Gordon growth model
Why do stocks have value?
- Pay dividends
- Rise in value generating capital gains
What is the required return?
The minimum amount of return the stockholder would be satisfied to earn (percentage).
What is a residual claimant?
Stockholders receive whatever remains after all other liabilities have been repaid by the corp.
Dividends
Payments made periodically (usually quarterly) + the board of directors sets the dividend price.
What does the generalized dividend valuation model show?
The current value of a share of stock can be calculated as the present value of the future dividend stream.
How does the gordon growth model differ from the generalized dividend valuation model?
The generalized dividend vm. expects the dividends to be infinite, the gordon growth model sets a limit.
What are the assumptions of the gordon growth model?
1) Dividends grow at a constant rate
2) Growth rate < required return
Who sets the stock market prices?
- The highest bidder
- Who can take the best advantage
How does information affect the price of a stock?
Superior information about an asset can increase its value by reducing its
risk (less uncertainty about future cash-flows).
Why will a buyer purchase a stock at discount cash flows at lower interest rate?
Because they have superior information which gives them less uncertainty and risk.
Why are stock prices volatile?
Because information is constantly changing.
What is the effect of expansionary monetary policy on stock prices?
Lower interest rates → lower Re → denominator decreases → stock value is raised.
What is the effect of contractionary monetary policy on stock prices?
Higher interest rates → higher Re → denominator increases → stock value is lower.
How can expansionary monetary policy affect g in the gordon growth model?
Lower interest rates → economy is stimulated → g increases → denominator decreases → stock value increases.
Adaptive expectations
Changes in expectations that occur slowly over time as the data for a variable evolves.
Rational expectations
Expectations will be identical to optimal forecasts (the best guess of the future) using all available information.
Why can expectations fail to be rational?
- Too much effort to find info
- Unaware of relevant info
What are the assumptions of rational expectation theory?
1) If there is a change in which the variable moves, expectations will change accordingly.
2) The forecast errors of expectations will on average be zero and cannot be predicted ahead of time.
Efficient market hypothesis
Expectations in the financial market are equal to optimal forecasts using all available information.
What does the efficient market hypothesis tells us about stock prices?
If Rof = Re, and Re = R, then Rof = R
What is arbitrage?
When market participants eliminate unexploited profit opportunities from the market.
Are stock prices predictable?
No: they follow a random walk behavior.
