Chapter 9. The Valuation of Common Stock. 1.The Expected Return (Copied from Unit02, slide 39)

Size: px
Start display at page:

Download "Chapter 9. The Valuation of Common Stock. 1.The Expected Return (Copied from Unit02, slide 39)"

Transcription

1 Readings Chapters 9 and 10 Chapter 9. The Valuation of Common Stock 1. The investor s expected return 2. Valuation as the Present Value (PV) of dividends and the growth of dividends 3. The investor s required return and stock valuation 4. Alternative valuation techniques: Multiplier models 5. Valuation and the efficient market hypothesis Valuation What is the value of a stock (or any asset)? The value of a stock lies in its ability to generate future income, either dividend yield or capital gain, or both. The process of figuring out the value of a stock (or any asset) is called valuation. There are several valuation methods, each with its advantages and disadvantages Valuation using Dividend Growth Model Alternative valuation methods: Valuation using P/E ratio Valuation using Cash flow 1.The Expected Return (Copied from Unit02, slide 39) E( D) E ( r) = + E( g) P E(r)= the expected return E(D)= the expected dividend or interest income P= the price of the asset E(g)=the expected growth in the value of the asset Example: An investor buys a stock for \$20/share and expects to earn a dividend of \$1/share for the year. He also expects to sell the stock for \$25/share after one year. What is his expected return? E( D) \$1 \$25 \$20 E( r) = + E( g) = + = = 0.25 = 25% P \$20 \$ Valuation as The Present Value of Dividends and the Growth of Dividends For an investment to be attractive, the expected return must equal to or exceed the investor s required return. Required return is the return an individual investor demands to justify the purchase of the stock. This return included the risk-free rate (rf), plus a premium for bearing the risk associated with investments in common stock (rmand beta). The valuation of a stock involves bringing all future cash inflows back to the present (using Present Value Factor) at the appropriate discount rate. Different investors may have different discount rates. For the individual investor, the discount rate is the required return. Decision: If the valuation exceeds the price of a stock, the stock is undervalued. Buy the stock. If the valuation is less than the price, the stock is overvalued. Short the stock Dividend Growth Valuation Model Dividend Grows at Rate g Notations: V=Valuation D 0 =Initial dividend (first year) k=discount rate=required return g=dividends annual growth rate (1 + g) If the dividend grows at the rate of g annually, V = D0 valuation is ( k g) Note the dividend valuation model with no growth is just a special case of the dividend growth valuation model with g=0) 5 6 1

2 2.2. Examples 1. Given the following data, what is the value of the stock? Required return (discount rate) k=12% Present dividend D 0 =\$1 Dividend growth rate g=6% Answer: This is a valuation case using dividend growth valuation model. 2. Now suppose this stock is traded in the market for \$18 a share. Should this investor (with a 12% required return) buy this stock? Answer: No. Because the stock s value is only \$17.67, less than the market price of \$18. Thus this stock is overvalued. D0 (1 + g) \$1*(1 + 6%) V = = = \$17.67 ( k g) (12% 6%) Given the following data, what is the value of the stock? Required return k=12% Present dividend D 0 =\$1 Dividend growth rate g=0% (no growth) Answer: This is a valuation case when there is no dividend growth. D0 ( 1+ g) D0 V = = = ( k g) k \$1 12% = \$ How to Valuate More Complicated Dividend Patterns? If the dividend patterns are more complicated, such as a combination of super growth for several years and slow growth later on, one can still use the dividend growth model. The only difference is that the equation setup is a bit more complicated. We will not get into the details, but there is an example in the textbook you can look at to get an idea. If the market price of this stock is over \$8.33, don t buy. If it s under \$8.33, buy Some Generalizations from the Dividend Growth Model The larger the initial dividend, the higher the valuation. The higher the dividend growth rate, the higher the valuation. The lower the required return (discount rate), the higher the valuation. 3. Required Return and Stock Valuation Note that in the previous examples a required return was just given to you. But how is the required return determined? Review the Capital Assets Pricing Model (CAPM) and the Security Market Line on Page 88 of Unit02 (I copied that slide on next page)

3 Page 88 of Unit02: Beta Coefficients and The Security Market Line The return on a stock depends on The risk free rate (r f ) The return on the market (r M ) The stock's beta (β) The return on a stock is r s = r f + (r M - r f )β E.g. If r M =6%, rf=3%, stock ABC β is 1.2 then return on stock ABC is r s = 3% + (6% - 3%)x1.2 =6.6% 3.1. Required Return r s on Slide 88 of Unit02 is the required return. In the context of stock valuation, this r s is typically denoted as k K=r s = r f + (r M -r f )β, where r f = the risk free rate (i.e.treasurebill rate) r M = the return on the market β= the stock's beta An Example of Computing Required Return The annual risk-free rate of return is 4%. The overall market rate of return is 12%. ABC stock as a Beta of 1.4. What is the required return for ABC stock, adjusting for its risk? Answer: The required return k is: k = rf + (rm - rf )β = 4% + (12% - 4%) *1.4 = 15.2% 3.3. An Example of Valuation Incorporating Risk-Adjusted Required Return Firm XYZ s current dividend is \$2.00 (D 0 ), which is expected to grow annually at 5% (g). The risk free rate is 3.5% (r f ), and the market is expected to grow at 10% (r M ). If the Firm XYZ stock has a Beta of 1.2, what should be the value of XYZ s stock? Answer: Step 1. Compute required return k=3.5%+(10%-3.5%)*1.2=3.5%+7.8%=11.3% Step 2. Compute valuation V using Dividend Growth Model: D (1 0 + g) \$2.00*(1 + 5%) V = = = \$33.33 ( k g) (11.3% 5%) Beta and Valuation If Beta is larger, the risk is higher. Thus the required return is higher to compensate for that risk. Assume dividend and dividend growth rate are the same, the stock with a higher beta has a lower value Advantages and Shortcomings of the Dividend Growth Model Advantages Theoretically sound Practically doable with assumptions can provide useful information beyond hunchs and intuitions. Shortcomings If a stock does not pay a dividend right now, as in this case of many growth stocks, valuation can be difficult. Beta can be different for the same stock, depending on data used to compute Beta. The risk-free rate is not an easy determination. Long-term Treasury Bill (TB) rate can be different from short-term TB rate Similar problems exist on rate of return of the market and dividend growth rate. Basically many assumptions need to be made in order for the Dividend Growth Model to work well

4 4. Alternative Valuation Techniques: Multiplier Models There are some alternative valuation techniques analysts use to identify stocks for purchase. These techniques include P/E ratio Price Earning ratio Cash flow P/S ratio Price Sales ratio PEG ratio P/E divided by the growth rate of Earnings Adjusted PEG Price/Book ratio Return on equity to Price/Book ratio Profit margin to Price/Book ratio 4.1. Valuation Using P/E Ratio P/E ratio is the price to earning ratio of a stock. E.g., If the current stock price is \$50, and earnings per year on the stock is \$20, then the P/E=50/20=2.5 Stock valuation using P/E: P=(m)(EPS) Where m is the appropriate P/E ratio. Note: I would rather write the formula as V=m*E, where V is valuation and E is earnings per share. However convention is such that in this type of P/E ratio model, notations are different. So I am following the textbook with these different notations. Please note that this P here is the same as the V in the Dividend Growth Model, and the EPS here is the same as E in the P/E ratio. E.g., If the financial analysts believe the appropriate P/E ratio (m) for a particular stock should be, say 5, and the earning per share (EPS) for this stock is \$3.5, then the value of this stock is P=m*EPS=5*\$3.5=\$ Weakness in the Use of P/E Ratio Question of the appropriate multiplier What is an appropriate P/E (m)? Today most stocks trade between P/E range. In the Dot-com bubble the average P/E had risen to 32. The collapse in earnings caused P/E to rise to 46.5 in A possible solution is to use current industrial average P/E ratio as the appropriate P/E (m). Differences in estimated earnings A particular year s earnings may contain special items that do not occur every year. Adjustments should be made for such events. Historical earnings may not predict future earnings Valuation Using Cash Flow Cash flow is the balance of the amounts of cash being received and paid by a business. The valuation process of using cash flow is essentially the same as is used with P/E ratio, except cash flow is substituted for earnings. Again, the determination of future cash flow and the determination of appropriate multiplier are at the discretion of the analyst Price to Book Ratio (P/B) and Price to Sales Ratio (P/S) P/B ratio is the ratio of stock price to the per-share book value (B). Book value is an accounting term denoting the company s total assets less its total liabilities. Per share book value is Book value / Number of outstanding shares P/S ratio is the ratio of stock price to the per share sales. Conceptually using P/B ratio or P/S ratio for valuation of stocks is the same as using P/E ratio. Same weaknesses apply 4.4. The PEG Ratio Standardizes the P/E ratio for growth P PEG = E Earnings growth rate Low PEG ratios (below 1.0) suggest undervaluation. E.g., If a stock s P/E is 15, and the per-share earning growth rate is 10%, PEG=15/10=

6 1. Measures of Stock Performance: Averages and Indexes Many averages and indexes have been developed to track security price movements, such as the Dow Jones averages and the S&P 500. The composition for these indexes differ. Dow Jones Industrial Average includes 30 companies. S&P 500 includes 500 companies The methods if calculation also differ: Price-weighted average Value-weighted average Equal-weighted average Geometric weighted average 1.1. A Price-weighted Average Price of stock A \$10 Price of stock B \$20 Price-weighted average is (\$10 + \$20)/2 = \$15 The Dow-Jones Industrial Average uses this method A Value-weighted Average Weights the prices by the number of shares outstanding Continue with the previous example: Price of stock A = \$10 Price of stock B = \$20 Additional information is needed for value-weighted average: Number of shares outstanding of stocks A: 1,000,000 Number of shares outstanding of stocks B: 10,000,000 Total value of each stock needs to be calculated Total value of stock A = \$10*1,000,000=\$10,000,000 Total value of stock B = \$20*10,000,000=\$200,000,000 Weighted Average Price is total value divided by total shares Weighted average price = \$210,000,000/(1,000, ,000,000) = \$19.09 The S&P 500 stock index uses the value-weighted average method An Equal-weighted Average This approach assumes equal dollar amount invested in each stock. Continue with previous example Price of stock A is \$10 Price of stock B is \$20. Assume one invests \$100 in each stock (equal dollar amount Share of A purchased = 100/10=10 Share of B purchased = 100/20=5 Average price of a share: \$200/(10+5)=\$200/15 = \$13.33 Note with this approach it does not matter whether you assume \$100 invested in each stock or \$1 million invested in each stock. The answer is the same A Geometric Average Instead of dividing, take the 1/n root. Example: Price of stock A = \$10 Price of stock B = \$20 n=2 (two stocks) Geometric average price of a share: (10)(20)^(1/2) = \$14.14 The Value-Line stock index uses the geometric average method Comparing Prices Over Time There are two main methods of comparison prices over time: Graphic illustrations Numbers: Rate of return We will first cover graphic illustrations, followed by market indexes using graphic illustrations. Then we will cover rate of return computations

7 Graphical Illustrations: Absolute Price vs. Relative Price Scale Often historical trend of stock prices are illustrated using graphs. While the horizontal axis is always Time (year, month, or day), the vertical axis can have different scales so interpretation needs to be carefully done. Absolute price scale: Equal dollar amount change as the vertical axis. Relative price scale: Equal percentage change as the vertical axis. Use of Different Scales to Illustrate Stock Price Movements Dollar scale each equal distance on the vertical axis is a \$5 increase Percentage scale, each equal distance on the vertical axis is a 100% increase Graphical Illustrations: Linear Scale vs. Log Scale For Composite Indexes, often there are two ways: Linear scale and Log scale Presentation of data on a log scale can be helpful when the data covers a large range of values the logarithm reduces this to a more manageable range. Next slide shows two Dow Jones Composite Index graphs: Linear scale and Log scale. Use of Linear vs. Log Scale: Dow Jones Industrial Average from 1928 to The above graph is in linear scale. Because there are lots of data points, the trend in the early years is difficult to see. The above graph is in log scale. The trend in the early years is much easier to see. However one needs to be careful when interpreting this graph Common Stock Market Indexes There are many stock market indexes, domestic and international. Yahoo Finance has a great list: Major world indices: Major U.S. indices: 2. Dow Jones Industrial Average Perhaps the most well-known index is the Dow Jones Industrial Average. Created by Charles Dow in Of the original 12, only GE is currently still part of the index. In 1916, number of stock in the index increased to 20. It increased to 30 in Currently comprised of 30 largest and most widely help public companies in the U.S. Price-weighted and scaled average. Scaled average means the divisor changes so that substitutions of one firm for another has no impact on the average. For a good description of the history and some interesting anecdotes see

8 Annual Price of the Dow Jones Industrial Average 1928 to 2011: Log Scale When first published it stood at The largest one day % gain was 15.34% on 3/15/1933. The largest one day % drop since 1914 was 22.61% on Black Monday 10/19/ Additional Aggregate Measures of the Stock Market Include: Standard & Poor's 500 stock index: Contains the stocks of 500 large-cap corporations. NYSE composite index Value Line Stock average Nasdaq composite index Dow Jones Wilshire 5000 index Additional Aggregate Measures of the Stock Market Russell 1000, Russell 2000, Russell S&P 400 MidCap S&P 600 SmallCap S&P Specialized Indexes Aggregate Measures of the Stock Market Prices and Correlations The graph shows 5- year trend in Dow Jones Industrial Average (^DJI), S&P (^GSPC), and NASDAC (^IXIC). One can see that the correlations among aggregate measures of the American stock markets is high Bond Averages In addition to stock indexes, there are aggregate measures of the bond market. Bond averages are expressed in yield instead of prices. Yield can be expressed in both dollars and percentage changes. Bond Indexes: Can be categorized based on their broad characteristics, such as whether they are government bonds, corporate bonds, high-yield bonds, mortgagebacked securities, etc. They can also be classified based on their credit rating or maturity. An example: Dow Jones Corporate Bond Index

9 Dow Jones Bond Average and Yields on Mergent s (Moody s) Aaa-Rated Bonds, Inverse relationship between bond price and yield. During the period covered in this graph, bond prices (Dow Jones Bond Average, blue line) was going down while yield ( gray line) was going up The Volatility Index (VIX) the fear index The VIX is a measure of investors expectations about near-term market volatility. The calculation of the VIX is based on the S&P 500 index options and is expressed in percentages (options are explained in later units). Low values suggest low volatility (e.g. VIX=10) High values suggest high volatility (e.g. VIX=50) Current VIX is around 30 (Sept. 2011) Historical Data on VIX (Linear Scale) 3.5. Securities Prices and Inflation Changes in Real Terms (Instead of Nominal) Another means of measuring securities price performance is to compare the measure with a general price index, such as Consumer Price Index (CPI). When adjusted for CPI, stock performance is much more modest Rates of Return on Investments Just as there are many ways to compute an average, there are several ways to compute a return. Holding period return Dollar-weighted return (also called: internal rate of return, true annualized rate of return) Time-weighted return (also called: average percentage return) This is a graph showing nominal NYSE index (blue line) and inflationadjusted NYSE index (red line). Note this graph adjusts to 2011 dollars so the 2011 nominal and real values are the same. The key point is to look at the slope of these lines: the real price increases are a lot less than the nominal price increases due to inflation

10 HPRP1PP D Holding Period Return (HPR) + = P 0 is purchase price, P 1 is sell price, D is dividend. The percentage earned on an investment during a period of time Example: You buy a stock for \$20. After a year the price rises to \$25 but falls back to \$22 at the end of the second year. The total dividend payment for the two years was \$2. What was the holding period return? Answer: In this case the holding period is two years. For holding period return only the beginning and ending prices matter, the middle price (\$25 in this case) does not matter. Holding period return=(\$22+\$2-\$20)/\$20=20% Major weakness of HPR Does not consider the length of time 4.2. Dollar-Weighted Rate of Return (Also called True Annualized Return or Internal Rate of Return ) This measure takes compounding into consideration. It is the discount rate that equates the cost of an investment with the present value of cash flows generated by the investment. See equation below. Solve for r. Computation can be very tedious. I usually use Excel and try different numbers of r in order to solve the equation. One can also use a financial calculator if the number of years are small. Note if the dividend amount is the same every year, one can simplify the dividend part of the equation using Present Value Factor Sum (PVFS, see Week 1 notes or FCS3450 notes) D1 Dn P1 P0 = n (1 + r) (1 + r) (1 + r) Weaknesses of the internal rate of return: - Assumes cash flows are reinvested at that internal rate of return. n Time-Weighted Rate of Return simple Average (also called Average Percentage Return) and Geometric Average Consider the previous example again. You buy a stock for \$20. After a year the price rises to \$25 but falls back to \$22 at the end of the second year. Dividends were \$1 per year. What was the true annualized return? Answer: = + +, 2 2 (1 + r ) (1 + r) (1 + r) Solving for r using Excel by trying different numbers for r, r=9.76% The time-weighted rate of return is to compute return for every year, and then take the average. Simple average is also called average percentage return. Geometric average is the true compound rate. Consider the previous example again. You buy a stock for \$20. After a year the price rises to \$25 but falls back to \$22 at the end of the second year. Dividends were \$1 per year. What is the average percentage return? What is the geometric time-weighted rate of return? Answer: Year 1 return=( )/20=30% Year 2 return=( )/25= -8% Simple average (Average percentage return)=(30%-8%)/2=11% Geometric average =[ (1+30%)(1-8%)]^(1/2) -1 = 9.36% Weakness of this measure: Compounding is not taken into consideration A Simplified Case: Return without Dividends If there is no dividend distribution the computation of return is greatly simplified. Here is an example: You buy a stock for \$20. After a year the price rises to \$25 but falls back to \$22 at the end of the second year. There is no dividend distribution. What was the (1) holding period return? (2) Dollar-weighted average return (true annualized return), and (3) time weighted average return (average percentage return)? Answer: 1. Holding period return: (22-20)/2=10% 2. True annualized return: 20=22/[(1+r)^2], r=4.88% 3. Average percentage return: Year 1 return=(25-20)/20=25% Year 2 return=(22-25)/25= -12.5% Average percentage return=(25%-12.5%)/2=6.25% Geometric time-weighted return=[(1+25%)(1-12.5%)]^(1/2)-1=4.58% 4.5. Which Rate of Return Measure is the Best? The dollar-weighted measure of rate of return makes the most sense in theoretical consistency. However the time-weighted rate of return can be useful to evaluate the performance of a portfolio manager

11 5. Studies of Investment Returns Studies indicate stocks earn about 9% annually on average. The Ibbotson results (the industry benchmark) data for common stocks: Mean: 10.4% Standard Deviation: 20.2%, meaning that 68% of the times the return fell between -10.2% to 30.6% Pay attentions to the issues of reinvestment assumption and time diversification when interpreting study results. 6. Reducing the Impact of Pric Fluctuation: Averaging Strategies Averaging is one strategy designed to reduce the impact of security price fluctuations. Two averaging methods: Dollar cost averaging through periodic purchase Averaging down -buying additional shares after prices fall These strategies may reduce the average cost of the stock

Chapter 9. The Valuation of Common Stock. 1.The Expected Return (Copied from Unit02, slide 36)

Readings Chapters 9 and 10 Chapter 9. The Valuation of Common Stock 1. The investor s expected return 2. Valuation as the Present Value (PV) of dividends and the growth of dividends 3. The investor s required

Unit 01. 1. Return computation with cash purchase vs. margin purchase

FCS 5510 Formula Sheet *Note: The formulas I expect you to know are colored in Red. They are either more conceptually based, or are more commonly used than the others. You need to have a passing familiarity

Unit06 Sample Homework Problems CHAPTER 10. INVESTMENT RETURNS AND AGGREGATE MEASURES OF STOCK MARKETS

Unit06 Sample Homework Problems CHAPTER 10. INVESTMENT RETURNS AND AGGREGATE MEASURES OF STOCK MARKETS 1. You buy a stock for \$40. After a year the price rises to \$50 but falls back to \$40 at the end of

FIN 432 Investment Analysis and Management Review Notes for Midterm Exam

FIN 432 Investment Analysis and Management Review Notes for Midterm Exam Chapter 1 1. Investment vs. investments 2. Real assets vs. financial assets 3. Investment process Investment policy, asset allocation,

Glossary of Investment Terms

online report consulting group Glossary of Investment Terms glossary of terms actively managed investment Relies on the expertise of a portfolio manager to choose the investment s holdings in an attempt

Introduction to Indices and Mutual Funds

Introduction to Indices and Mutual Funds Week 2: Chapter 2, 4 Nikunj Kapadia 1 Market Indices (Chapter 2) What is an index? Why are stock market indices important? What are the difference ways in which

Review for Exam 2 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems You are not responsible for any topics that are not covered in the lecture note

CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS

1 CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS (f) 1 The three step valuation process consists of 1) analysis of alternative economies and markets, 2) analysis of alternative industries

A Review of Cross Sectional Regression for Financial Data You should already know this material from previous study

A Review of Cross Sectional Regression for Financial Data You should already know this material from previous study But I will offer a review, with a focus on issues which arise in finance 1 TYPES OF FINANCIAL

AFM 472. Midterm Examination. Monday Oct. 24, 2011. A. Huang

AFM 472 Midterm Examination Monday Oct. 24, 2011 A. Huang Name: Answer Key Student Number: Section (circle one): 10:00am 1:00pm 2:30pm Instructions: 1. Answer all questions in the space provided. If space

CHAPTER 10 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM)

CHAPTER 10 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM) Answers to Concepts Review and Critical Thinking Questions 1. Some of the risk in holding any asset is unique to the asset in question.

ANALYSIS AND MANAGEMENT

ANALYSIS AND MANAGEMENT T H 1RD CANADIAN EDITION W. SEAN CLEARY Queen's University CHARLES P. JONES North Carolina State University JOHN WILEY & SONS CANADA, LTD. CONTENTS PART ONE Background CHAPTER 1

Chapter 7 Stocks, Stock Valuation, and Stock Market Equilibrium ANSWERS TO END-OF-CHAPTER QUESTIONS

Chapter 7 Stocks, Stock Valuation, and Stock Market Equilibrium ANSWERS TO END-OF-CHAPTER QUESTIONS 7-1 a. A proxy is a document giving one person the authority to act for another, typically the power

ACTIVITY 4.1 READING A STOCK TABLE

ACTIVITY 4.1 READING A STOCK TABLE 1. Overview of Financial Reporting A wide variety of media outlets report on the world of stocks, mutual funds, and bonds. One excellent source is The Wall Street Journal,

Mid-Term Spring 2003

Mid-Term Spring 2003 1. (1 point) You want to purchase XYZ stock at \$60 from your broker using as little of your own money as possible. If initial margin is 50% and you have \$3000 to invest, how many shares

Basic Financial Tools: A Review. 3 n 1 n. PV FV 1 FV 2 FV 3 FV n 1 FV n 1 (1 i)

Chapter 28 Basic Financial Tools: A Review The building blocks of finance include the time value of money, risk and its relationship with rates of return, and stock and bond valuation models. These topics

Chapter 11. Stocks and Bonds. How does this distribution work? An example. What form do the distributions to common shareholders take?

Chapter 11. Stocks and Bonds Chapter Objectives To identify basic shareholder rights and the means by which corporations make distributions to shareholders To recognize the investment opportunities in

NIKE Case Study Solutions

NIKE Case Study Solutions Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the

Chapter 1 The Investment Setting

Chapter 1 he Investment Setting rue/false Questions F 1. In an efficient and informed capital market environment, those investments with the greatest return tend to have the greatest risk. Answer: rue

Final Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator

University of Stavanger (UiS) Stavanger Masters Program Final Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator The number in brackets is the weight for each problem. The weights

FCS5510 Sample Homework Problems and Answer Key Unit03 CHAPTER 6. INVESTMENT COMPANIES: MUTUAL FUNDS

FCS5510 Sample Homework Problems and Answer Key Unit03 CHAPTER 6. INVESTMENT COMPANIES: MUTUAL FUNDS PROBLEMS 1. What is the net asset value of an investment company with \$10,000,000 in assets, \$500,000

Primary Market - Place where the sale of new stock first occurs. Initial Public Offering (IPO) - First offering of stock to the general public.

Stock Valuation Primary Market - Place where the sale of new stock first occurs. Initial Public Offering (IPO) - First offering of stock to the general public. Seasoned Issue - Sale of new shares by a

THE STOCK MARKET GAME GLOSSARY

THE STOCK MARKET GAME GLOSSARY Accounting: A method of recording a company s financial activity and arranging the information in reports that make the information understandable. Accounts payable: The

INVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK

INVESTMENTS IN OFFSHORE OIL AND NATURAL GAS DEPOSITS IN ISRAEL: BASIC PRINCIPLES ROBERT S. PINDYCK Bank of Tokyo-Mitsubishi Professor of Economics and Finance Sloan School of Management Massachusetts Institute

FTS Real Time System Project: Portfolio Diversification Note: this project requires use of Excel s Solver

FTS Real Time System Project: Portfolio Diversification Note: this project requires use of Excel s Solver Question: How do you create a diversified stock portfolio? Advice given by most financial advisors

Non-FDIC Insured May Lose Value No Bank Guarantee. Time-Tested Investment Strategies for the Long Term

Time-Tested Investment Strategies for the Long Term Invest for the Long-Term Stay the Course Through Ups and Downs History shows that the market goes up and the market goes down. While there may be short-term

BASKET A collection of securities. The underlying securities within an ETF are often collectively referred to as a basket

Glossary: The ETF Portfolio Challenge Glossary is designed to help familiarize our participants with concepts and terminology closely associated with Exchange- Traded Products. For more educational offerings,

Why invest in stocks?

Joseph E. Buffa, Equity Sector Analyst Kent A. Newcomb, CFA, Equity Sector Analyst Why invest in stocks? 2015 Why should someone invest in stocks? Historically, stocks have performed well when compared

Answers to Concepts in Review 1. A portfolio is simply a collection of investments assembled to meet a common investment goal. An efficient portfolio is a portfolio offering the highest expected return

Key Concepts and Skills

Chapter 10 Some Lessons from Capital Market History Key Concepts and Skills Know how to calculate the return on an investment Understand the historical returns on various types of investments Understand

Investment Finance 421-002 Prototype Midterm I

Investment Finance 421-002 Prototype Midterm I The correct answer is highlighted by a *. Also, a concise reasoning is provided in Italics. 1. are an indirect way U. S. investor can invest in foreign companies.

Key Concepts and Skills Chapter 8 Stock Valuation

Key Concepts and Skills Chapter 8 Stock Valuation Konan Chan Financial Management, Spring 2016 Understand how stock prices depend on future dividends and dividend growth Be able to compute stock prices

Virtual Stock Market Game Glossary

Virtual Stock Market Game Glossary American Stock Exchange-AMEX An open auction market similar to the NYSE where buyers and sellers compete in a centralized marketplace. The AMEX typically lists small

CAPITALIZATION/DISCOUNT

Fundamentals, Techniques & Theory CAPITALIZATION/DISCOUNT RATES CHAPTER FIVE CAPITALIZATION/DISCOUNT RATES I. OVERVIEW Money doesn t always bring happiness People with ten million dollars are no happier

Econ 422 Summer 2006 Final Exam Solutions

Econ 422 Summer 2006 Final Exam Solutions This is a closed book exam. However, you are allowed one page of notes (double-sided). Answer all questions. For the numerical problems, if you make a computational

NASAA Investment Adviser Competency Exam (Series 65) Exam Specifications and Outline (Effective 1/1/2010)

NASAA Investment Adviser Competency Exam (Series 65) Exam Specifications and Outline (Effective 1/1/2010) CONTENT AREA # of Items 1. Economic Factors and Business Information 19 (14%) A. Basic economic

Review for Exam Instructions: Please read carefully The exam will have 1 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation questions.

Practice Questions for Midterm II

Finance 333 Investments Practice Questions for Midterm II Winter 2004 Professor Yan 1. The market portfolio has a beta of a. 0. *b. 1. c. -1. d. 0.5. By definition, the beta of the market portfolio is

Cost of Capital, Valuation and Strategic Financial Decision Making

Cost of Capital, Valuation and Strategic Financial Decision Making By Dr. Valerio Poti, - Examiner in Professional 2 Stage Strategic Corporate Finance The financial crisis that hit financial markets in

Global Financial Management

Global Financial Management Bond Valuation Copyright 999 by Alon Brav, Campbell R. Harvey, Stephen Gray and Ernst Maug. All rights reserved. No part of this lecture may be reproduced without the permission

CFA Examination PORTFOLIO MANAGEMENT Page 1 of 6

PORTFOLIO MANAGEMENT A. INTRODUCTION RETURN AS A RANDOM VARIABLE E(R) = the return around which the probability distribution is centered: the expected value or mean of the probability distribution of possible

Unit01. Introduction, Creation of Financial Assets, and Security Markets

FCS 5510 Concept Review Notes: Midterm Review Notes Unit01. Introduction, Creation of Financial Assets, and Security Markets Chapter 01. Definition of investment Portfolio Primary and secondary markets

Chapter 7 Risk, Return, and the Capital Asset Pricing Model

Chapter 7 Risk, Return, and the Capital Asset Pricing Model MULTIPLE CHOICE 1. Suppose Sarah can borrow and lend at the risk free-rate of 3%. Which of the following four risky portfolios should she hold

Capital Market Theory: An Overview. Return Measures

Capital Market Theory: An Overview (Text reference: Chapter 9) Topics return measures measuring index returns (not in text) holding period returns return statistics risk statistics AFM 271 - Capital Market

Dividend valuation models Prepared by Pamela Peterson Drake, Ph.D., CFA

Dividend valuation models Prepared by Pamela Peterson Drake, Ph.D., CFA Contents 1. Overview... 1 2. The basic model... 1 3. Non-constant growth in dividends... 5 A. Two-stage dividend growth... 5 B. Three-stage

Mutual Funds and Other Investment Companies. Chapter 4

Mutual Funds and Other Investment Companies Chapter 4 Investment Companies financial intermediaries that collect funds from individual investors and invest in a portfolio of assets shares = claims to portfolio

Why invest in stocks?

Joseph E. Buffa, Equity Sector Analyst Kent A. Newcomb, CFA, Equity Sector Analyst Why invest in stocks? 2014 Why should someone invest in stocks? Because historically, stocks have performed well when

Chapter Seven STOCK SELECTION

Chapter Seven STOCK SELECTION 1. Introduction The purpose of Part Two is to examine the patterns of each of the main Dow Jones sectors and establish relationships between the relative strength line of

CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES

CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES 1. Expectations hypothesis. The yields on long-term bonds are geometric averages of present and expected future short rates. An upward sloping curve is

1. What are the three types of business organizations? Define them

Written Exam Ticket 1 1. What is Finance? What do financial managers try to maximize, and what is their second objective? 2. How do you compare cash flows at different points in time? 3. Write the formulas

CHAPTER 8 STOCK VALUATION

CHAPTER 8 STOCK VALUATION Answers to Concepts Review and Critical Thinking Questions 5. The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred.

Porter, White & Company

Porter, White & Company Optimizing the Fixed Income Component of a Portfolio White Paper, September 2009, Number IM 17.2 In the White Paper, Comparison of Fixed Income Fund Performance, we show that a

Running head: THE VALUATION OF WAL-MART 1

Running head: THE VALUATION OF WAL-MART 1 The Valuation of Wal-Mart CPT Becky Lux, CPT Ino Ruiz, and ENS Jujuane Hairston Army-Baylor MHA/MBA Graduate Program THE VALUATION OF WAL-MART 2 In fiscal year

Financial Instruments. Chapter 2

Financial Instruments Chapter 2 Major Types of Securities debt money market instruments bonds common stock preferred stock derivative securities 1-2 Markets and Instruments Money Market debt instruments

Chapter 11. Topics Covered. Chapter 11 Objectives. Risk, Return, and Capital Budgeting

Chapter 11 Risk, Return, and Capital Budgeting Topics Covered Measuring Market Risk Portfolio Betas Risk and Return CAPM and Expected Return Security Market Line CAPM and Stock Valuation Chapter 11 Objectives

Presented to the National Association of Insurance Commissioners Life Risk-Based Capital Working Group March 2001 Nashville, TN

Comments from the American Academy of Actuaries Life-Risk Based Capital Committee on a Letter Commenting Upon the Proposed Change to the Treatment of Common Stock in the Life Risk-Based Capital Formula

CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES

CHAPTER : THE TERM STRUCTURE OF INTEREST RATES CHAPTER : THE TERM STRUCTURE OF INTEREST RATES PROBLEM SETS.. In general, the forward rate can be viewed as the sum of the market s expectation of the future

Introduction To Financial Markets & Investing

Introduction To Financial Markets & Investing Matthew Lawson, M.D. Getting Started A true story Internal Medicine Intern Recently married Husband has Financial Planner assigned through his employer Neither

THE ROLE DIVIDENDS CAN PLAY IN INTERNATIONAL EQUITY INVESTING

THE ROLE DIVIDENDS CAN PLAY IN INTERNATIONAL EQUITY INVESTING Robert C. Sharpe, Vice President and Portfolio Manager, Heartland Advisors, Inc. Dr. G. Kevin Spellman, CFA, Director of Investment Management

Forecasting and Valuation of Enterprise Cash Flows 1. Dan Gode and James Ohlson

Forecasting and Valuation of Enterprise Cash Flows 1 1. Overview FORECASTING AND VALUATION OF ENTERPRISE CASH FLOWS Dan Gode and James Ohlson A decision to invest in a stock proceeds in two major steps

3. You have been given this probability distribution for the holding period return for XYZ stock:

Fin 85 Sample Final Solution Name: Date: Part I ultiple Choice 1. Which of the following is true of the Dow Jones Industrial Average? A) It is a value-weighted average of 30 large industrial stocks. )

Cost of Capital and Project Valuation

Cost of Capital and Project Valuation 1 Background Firm organization There are four types: sole proprietorships partnerships limited liability companies corporations Each organizational form has different

GLOSSARY OF INVESTMENT-RELATED TERMS FOR NATIONAL ELECTRICAL ANNUITY PLAN PARTICIPANTS

GLOSSARY OF INVESTMENT-RELATED TERMS FOR NATIONAL ELECTRICAL ANNUITY PLAN PARTICIPANTS General Information This Glossary of Investment-Related Terms for National Electrical Annuity Plan Participants (the

COMMUNITY FOUNDATION OF GREATER MEMPHIS, INC. INVESTMENT GUIDELINES FOR MONEY MARKET POOL

INVESTMENT GUIDELINES FOR MONEY MARKET POOL discretionary Money Market Pool is expected to pursue their stated investment strategy and follow the investment guidelines and objectives set forth herein.

Chapter 3 Fixed Income Securities

Chapter 3 Fixed Income Securities Road Map Part A Introduction to finance. Part B Valuation of assets, given discount rates. Fixed-income securities. Stocks. Real assets (capital budgeting). Part C Determination

( ) ( )( ) ( ) 2 ( ) 3. n n = 100 000 1+ 0.10 = 100 000 1.331 = 133100

Mariusz Próchniak Chair of Economics II Warsaw School of Economics CAPITAL BUDGETING Managerial Economics 1 2 1 Future value (FV) r annual interest rate B the amount of money held today Interest is compounded

What you will learn today. Different categories of investments Choosing your investment mix Common investor pitfalls Determining your next steps

Investing 101 What you will learn today Different categories of investments Choosing your investment mix Common investor pitfalls Determining your next steps 2 Asset Allocation One of Your Most Important

FNCE 301, Financial Management H Guy Williams, 2006

REVIEW We ve used the DCF method to find present value. We also know shortcut methods to solve these problems such as perpetuity present value = C/r. These tools allow us to value any cash flow including

Additional Practice Questions for Midterm I

1 Finance 333 Investments Additional Practice Questions for Midterm I Winter 2004 Professor Yan 1. Financial assets. A) directly contribute to the country's productive capacity *B) indirectly contribute

Saving and Investing 101 Preparing for the Stock Market Game. Blue Chips vs. Penny Stocks

Saving and Investing 101 Preparing for the Stock Market Game ============================================================================== Size Segmentation Blue Chips vs. Penny Stocks Blue chips, like

Equity Risk Premium Article Michael Annin, CFA and Dominic Falaschetti, CFA

Equity Risk Premium Article Michael Annin, CFA and Dominic Falaschetti, CFA This article appears in the January/February 1998 issue of Valuation Strategies. Executive Summary This article explores one

Achievement of Market-Friendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development

Achievement of Market-Friendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development Equity Analysis, Portfolio Management, and Real Estate Practice Quizzes

Stock valuation. Price of a First period's dividends Second period's dividends Third period's dividends = + + +... share of stock

Stock valuation A reading prepared by Pamela Peterson Drake O U T L I N E. Valuation of common stock. Returns on stock. Summary. Valuation of common stock "[A] stock is worth the present value of all the

Equity Valuation. Lecture Notes # 8. 3 Choice of the Appropriate Discount Rate 2. 4 Future Cash Flows: the Dividend Discount Model (DDM) 3

Equity Valuation Lecture Notes # 8 Contents About Valuation 2 2 Present-Values 2 3 Choice of the Appropriate Discount Rate 2 4 Future Cash Flows: the Dividend Discount Model (DDM) 3 5 The Two-Stage Dividend-Growth

Balanced fund: A mutual fund with a mix of stocks and bonds. It offers safety of principal, regular income and modest growth.

Wealth for Life Glossary Aggressive growth fund: A mutual fund that aims for the highest capital gains. They often invest in smaller emerging companies that offer maximum growth potential. Adjustable Rate

Financial ratio analysis

Financial ratio analysis A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction 2. Liquidity ratios 3. Profitability ratios and activity ratios 4. Financial leverage ratios 5. Shareholder

Valuation Equity Analysis II: Relative Valuation Models. Valuation Models. Price Multiples. Price to Earnings. Rationales for using P/E

Valuation Equity Analysis II: Relative Valuation Models Valuation is the estimation of an asset s value based either on variables perceived to be related to future investment returns or on comparisons

SAMPLE MID-TERM QUESTIONS

SAMPLE MID-TERM QUESTIONS William L. Silber HOW TO PREPARE FOR THE MID- TERM: 1. Study in a group 2. Review the concept questions in the Before and After book 3. When you review the questions listed below,

Investing in Stocks McGraw-Hill/Irwin Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 14-1 Invest in stocks Learning Objectives Identify the most important features of common and

Common Stock. Corporate securities. Basic definitions

Common Stock Investing in common stock Dividends and capital gains Stodgy and safe vs. fledgling and risky Corporate securities Corporations raise money or capital from investors like you and me by issuing

FINC 3630: Advanced Business Finance Additional Practice Problems Accounting For Financial Management 1. Calculate free cash flow for Home Depot for the fiscal year-ended February 1, 2015 (the 2014 fiscal

Investment, Time, and Present Value

Investment, Time, and Present Value Contents: Introduction Future Value (FV) Present Value (PV) Net Present Value (NPV) Optional: The Capital Asset Pricing Model (CAPM) Introduction Decisions made by a

Non-FDIC Insured May Lose Value No Bank Guarantee. Time-Tested Investment Strategies for the Long Term

Non-FDIC Insured May Lose Value No Bank Guarantee Time-Tested Investment Strategies for the Long Term Rely on These Four Time-Tested Strategies to Keep You on Course. Buy Right and Sit Tight Keep Your

CHAPTER 15: THE TERM STRUCTURE OF INTEREST RATES

Chapter - The Term Structure of Interest Rates CHAPTER : THE TERM STRUCTURE OF INTEREST RATES PROBLEM SETS.. In general, the forward rate can be viewed as the sum of the market s expectation of the future

Lesson 16. Investing in stocks. www.dirhami.ae

Lesson 16 Investing in stocks www.dirhami.ae Lesson 16 Investing in stocks What Is a Stock? Technically, a share of stock is a form of ownership or equity in a publicly traded company. A publicly traded

Factors Influencing Price/Earnings Multiple

Learning Objectives Foundation of Research Forecasting Methods Factors Influencing Price/Earnings Multiple Passive & Active Asset Management Investment in Foreign Markets Introduction In the investment

t = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3

MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate

Chapter 6. Interest Rates And Bond Valuation. Learning Goals. Learning Goals (cont.)

Chapter 6 Interest Rates And Bond Valuation Learning Goals 1. Describe interest rate fundamentals, the term structure of interest rates, and risk premiums. 2. Review the legal aspects of bond financing

PowerShares Smart Beta Income Portfolio 2016-1 PowerShares Smart Beta Growth & Income Portfolio 2016-1 PowerShares Smart Beta Growth Portfolio 2016-1

PowerShares Smart Beta Income Portfolio 2016-1 PowerShares Smart Beta Growth & Income Portfolio 2016-1 PowerShares Smart Beta Growth Portfolio 2016-1 The unit investment trusts named above (the Portfolios

What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated?

What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? HOCK international - 2004 1 HOCK international - 2004 2 How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated? HOCK

Bond Valuation. What is a bond?

Lecture: III 1 What is a bond? Bond Valuation When a corporation wishes to borrow money from the public on a long-term basis, it usually does so by issuing or selling debt securities called bonds. A bond

Common Stock Valuation & Performance Measurement

Module 4 Common Stock Valuation & Performance Measurement by Jason G. Hovde, CIMA, CFP, APMA 7350 This publication may not be duplicated in any way without the express written consent of the publisher.

Stock Valuation: Gordon Growth Model. Week 2

Stock Valuation: Gordon Growth Model Week 2 Approaches to Valuation 1. Discounted Cash Flow Valuation The value of an asset is the sum of the discounted cash flows. 2. Contingent Claim Valuation A contingent

Chapter 5 Risk and Return ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS

Chapter 5 Risk and Return ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 5-1 a. Stand-alone risk is only a part of total risk and pertains to the risk an investor takes by holding only one asset. Risk is

Workplace Education Series. Building a Portfolio for Any Weather

Building a Portfolio for Any Weather The Retirement Savings Series Part 1: Getting on the Right Path with Your Workplace Savings Understand the many advantages of saving at the workplace Find money in

Test3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs -25-20 -15

Test3 1. The market value of Charcoal Corporation's common stock is \$20 million, and the market value of its riskfree debt is \$5 million. The beta of the company's common stock is 1.25, and the market

a. What is the sum of the prices of all the shares in the index before the stock split? The equation for computing the index is: N P i i 1

7 Stock Index Futures: Introduction 44 Answers to Questions and Problems 1. Assume that the DJIA stands at 8340.00 and the current divisor is 0.25. One of the stocks in the index is priced at \$100.00 and

CHAPTER 2. Asset Classes. the Money Market. Money market instruments. Capital market instruments. Asset Classes and Financial Instruments

2-2 Asset Classes Money market instruments CHAPTER 2 Capital market instruments Asset Classes and Financial Instruments Bonds Equity Securities Derivative Securities The Money Market 2-3 Table 2.1 Major