Capital Markets: Stock Markets Overview

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Questions and Answers

What does the Asset-Based Valuation method primarily emphasize?

Acquisition costs of previous assets

Growth potential of the company

Historical prices of completed transactions

Fair market value of net assets owned (correct)

What factor is primarily used to determine a company’s equity in the Book-Value Approach?

Fair market value of total assets

Previous acquisition cost (correct)

Projected future earnings

Market performance of similar entities

What is meant by capital structure?

The stock price movements in the market

The cash flow from operating activities

The mix of investor-supplied funds like debt and equity (correct)

Only the total equity amount of the company

Behavioral Finance encompasses which of the following concepts?

Mental accounting and herding Signup and view all the answers

What does the optimal capital structure aim to achieve?

Maximize the stock’s intrinsic value Signup and view all the answers

Which psychological factor refers to the tendency to mimic others' financial behaviors?

Herd behavior Signup and view all the answers

How does the emotional gap affect decision-making?

Leads to decisions based on extreme emotions Signup and view all the answers

What is a key relevance of the Precedent Transactions approach?

It relies heavily on recent sales of similar entities Signup and view all the answers

What is the primary goal of financial managers in relation to stock prices?

To maximize stock prices Signup and view all the answers

What characterizes physical location stock exchanges?

They have designated physical locations and conduct auction markets. Signup and view all the answers

Which of the following best describes the over-the-counter (OTC) market?

A network of brokers and dealers connected electronically. Signup and view all the answers

What is the main purpose of equity valuation?

To estimate the value of a firm or its security. Signup and view all the answers

The comparable approach in equity valuation involves which of the following?

Comparing a company’s equity to its competitors or firms in similar sectors. Signup and view all the answers

Which of the following is NOT part of the dealer market system?

Traders who operate on a physical exchange floor. Signup and view all the answers

What technique underlies the assumptions of equity valuation?

That a firm's underlying business fundamentals drive security value. Signup and view all the answers

In the context of stock markets, what is meant by 'making a market'?

Holding inventories of securities to facilitate trading. Signup and view all the answers

Study Notes

Capital Markets

Stock Markets

Stock market prices reflect the value of firms’ stocks, crucial for financial management aiming to maximize stock prices.
Two main types of market procedures exist:
- Physical Location Stock Exchanges: Registered entities with physical trading floors, conducting auction markets for listed securities. Governed by elected boards.
- Over-The-Counter (OTC): An electronic network of brokers and dealers trading unlisted securities; includes dealer markets where transactions are conducted outside physical exchanges.

Equity Valuation

The goal of equity valuation is to estimate a firm's or security's value, primarily driven by the underlying business fundamentals.
Key methods of valuing companies:
- Comparables Approach: Compares a company’s equity value with that of similar firms in the industry.
- Discounted Cash Flow (DCF): Values equity based on projected future cash flows discounted to present value; relies on solid forecasting data.
- Precedent Transactions: Uses historical M&A transaction prices of similar companies for valuation.
- Asset-Based Valuation: Values equity based on the fair market value of net assets, ideal for firms with significant tangible assets.
- Book-Value Approach: Values equity using acquisition costs, relevant for stable companies with minimal growth.

Capital Structure

Capital comprises investor-supplied funds: debt, preferred stock, common stock, and retained earnings.
Excludes accounts payable and accruals since they originate from operational activities, not direct investments.
Defined as the percentage mix of each capital type, totaling 100%.
An optimal capital structure increases intrinsic stock value and reduces the weighted average cost of capital (WACC).

Behavioral Finance

Behavioral finance studies psychological influences on financial markets, covering five main concepts:
- Mental Accounting: Individuals allocate funds for specific purposes psychologically, affecting spending and investment decisions.
- Herd Behavior: Investors often follow the majority's financial actions, leading to market trends such as rallies or sell-offs.
- Emotional Gap: Extreme emotions (like fear or excitement) can hinder rational decision-making, impacting investment choices.
- Anchoring: Refers to setting spending levels based on references, such as budgets, influencing financial behavior.

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Description

This quiz covers the fundamentals of capital markets, focusing specifically on stock markets. It examines how stock prices are established and the significance of stock markets to financial management. Understanding these concepts is essential for anyone involved in managing a business.