Stock Markets, Common Stock, Valuation of Common Stock

Question 1

Describe financial contagion

Answer 1

Any movement in the US equities market serves as a signal of what may/would happen to the world economy

Question 2

Give the formula for dividend yield

Answer 2

DIV / close share price

Question 3

Give formula for price to earnings ratio

Answer 3

P/E = close price / EPS

Question 4

How are dividends and EPS linked

Answer 4

Dividends are a portion of EPS

Question 5

Give formula for expected return

Answer 5

(D1 + P1 - P0) / P0

Question 6

Give the formula for the dividend discount model

Answer 6

P0 = sum(t=1 to infinity) Dt / (1+r)^t

Question 7

Why will investors with different horizons come to the same conclusion about the current price of a stock?

Answer 7

As t increases to infinity, dividends make up more and more of the current price of the stock until future sales price is negligible

Question 8

What is the assumption of the Gordon Growth Model?

Answer 8

Future dividends grow at a constant rate into the indefinite future

Question 9

Give the formula for gordon growth model if D0 is unknown

Answer 9

P0 = D1 / (r-g)

Question 10

Give the formula for the gordon growth model if D0 is known

Answer 10

P0 = D0(1+g) / (r-g)

Question 11

What is a problem with the gordon growth model?

Answer 11

Assumes constant growth, which is unrealistic

Question 12

Give the formula for the dividend discount model with no growth

Answer 12

P0 = D1 / r

Question 13

If there is no growth, what is the company doing with earnings?

Answer 13

Paying them all as dividends

Question 14

What are growth stock investors interested in?

Answer 14

Capital gains, so they are more interested in future growth of earnings than next year’s dividends

Question 15

What are income stocks mainly bought for?

Answer 15

Cash dividends

Question 16

Give formula for EPS

Answer 16

EPS = earnings / number of shares

Question 17

What is the payout ratio and its formula?

Answer 17

Fraction of earnings payed out as dividends

p = D / EPS

Question 18

What is the plowback ratio?

Answer 18

b = 1 - p

Question 19

What is book value?

Answer 19

cumulative retained earnings, values can be extracted from companies balance sheet

Question 20

What the formula for return on book value?

Answer 20

Earnings / BV

Question 21

Define growth opportunities

Answer 21

Investment opportunities that can earn expected returns higher than the required rate of return on capital

Question 22

Relate growth to return on equity

Answer 22

g = ROE * b

Question 23

What is expected of current price if payout ratio is high / increases?

Answer 23

g goes down as plowback ratio is reduced / decreases, so expect a lower P0