Week 3 - Stocks and Stock Markets Flashcards
What are the two types of shares?
The Two main types of shares are:
- Ordinary Shares (or Common Stocks)
- Preference Shares (Preferred Stocks)
What are ordinary shares?
Ordinary Shares (or Common Stocks)
Owner of firm
Residual claim on profits (after tax and payment of interest on debt) – may receive nothing if earnings are low
Voting rights – e.g., “voting right” to appoint the board of directors and the auditors
What are Preference Shares (Preferred Stocks)?
Preference Shares (Preferred Stocks)
Claim on dividends that takes preference over ordinary shareholders.
Often dividends are a pre-defined rate (fixed or floating) and usually cumulative (any shortfall in dividend is made up in future years).
Usually non-voting but often grant voting rights if preferred dividends have not been paid.
If the firm goes into liquidation, payments to preference shareholders are paid after those to debt-holders but before shareholders of ordinary stocks.
What is a primary market?
Primary Market is a Market for the sale of new securities by corporations.
What is a Secondary Market?
Secondary Market is a Market in which previously issued securities are traded among investors.
What is an Electronic Communication Networks (ECNs)?
Electronic Communication Networks (ECNs) is A number of computer networks that connect traders with each other.
What is the Dow Jones Industrial Average (DJIA)?
Dow Jones Industrial Average (DJIA)
30 large ‘blue-chip’ corporations
Price-weighted average
Composition changes to reflect changes in the economy
Feb 2008 Bank of America and Chevron replaced Altria Group and Honeywell International
What are Exchange Traded Funds (ETFs)?
A basket of stocks that tracks a particular sector, investment style, geographical area, commodities, or the market as whole
Wahat are the benefits of ETFS?
Popular due to
Tax Efficiency
Low Transaction Costs
Diversify Portfolio Easily;
Low management fees
High Liquidity
Flexibility
Innovation
What is intrinsic value?
Intrinsic value is the “true” (fair) value of an asset (e.g., common stocks, bonds, real assets, etc.).
Intrinsic value is defined as the present value of firm’s future net cash flows discounted by the firm’s required rate of return (or cost of capital)
What are the main methods of equity valuation?
Balance Sheet Methods
Book Value - Net worth of the firm according to the balance sheet
Liquidation Value
Replacement Value
Relative valuation & market multiples
e.g., Price/Earnings Ratios - Price per share divided by earnings per share
Discounted Cash Flow Models
Dividend Discount Models Cost of Equity
Free Cash Flow Models Cost of Capital
Residual Income Models Cost of Equity
What is the balance sheet model of valuing stocks?
Balance Sheet
Difference between firm assets and liabilities (equity)
Divide equity by the number of shares outstanding to get the value of individual shares
Different firms report their balance sheets differently
Hard to compare two firms, while bonds can be compared very easily
Book values are based on historical cost, not actual market values
It is possible, but uncommon, for market value to be less than book value.
The minimum value based on the Balance Sheet Model is the liquidation value per share.
What is ROE?
Definition of ROE
ROE is a measure of the company’s financial performance (or profitability) in relation to its equity.
e.g., for many years, Microsoft paid no dividends because the company reinvested its profit for further growth that boosted its profitability
What is 𝑷𝒂𝒚𝒐𝒖𝒕 𝒓𝒂𝒕𝒊𝒐?
𝑷𝒂𝒚𝒐𝒖𝒕 𝒓𝒂𝒕𝒊𝒐=𝑓𝑟𝑎𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑎𝑖𝑑 𝑜𝑢𝑡 𝑎𝑠 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
What is 𝑷𝒍𝒐𝒘𝒃𝒂𝒄𝒌 𝒓𝒂𝒕𝒊𝒐?
𝑷𝒍𝒐𝒘𝒃𝒂𝒄𝒌 𝒓𝒂𝒕𝒊𝒐=𝑓𝑟𝑎𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑟𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝑏𝑦 𝑡ℎ𝑒 𝑓𝑖𝑟𝑚
What must the 𝑷𝒂𝒚𝒐𝒖𝒕 𝒓𝒂𝒕𝒊𝒐+𝑷𝒍𝒐𝒘𝒃𝒂𝒄𝒌 𝒓𝒂𝒕𝒊𝒐=?
𝑷𝒂𝒚𝒐𝒖𝒕 𝒓𝒂𝒕𝒊𝒐+𝑷𝒍𝒐𝒘𝒃𝒂𝒄𝒌 𝒓𝒂𝒕𝒊𝒐=𝟏
How to remember the plowback ratio?
“Plowback”: Refers to the act of reinvesting profits back into the company. It’s like a farmer plowing back seeds into the soil to grow more crops in the future.
