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Questions and Answers
Which of the following are reasons that make valuing a share of stock more difficult than valuing a bond? (Select all that apply)
Which of the following are reasons that make valuing a share of stock more difficult than valuing a bond? (Select all that apply)
- The required rate of return is unobservable (correct)
- Dividends are unknown (correct)
- Dividends are unknown but certain
- Stock has no set maturity (correct)
- Different stock issues have different maturity dates
If a zero-dividend stock is purchased for $80 and sold one year later for $84, what is the 1-year return?
If a zero-dividend stock is purchased for $80 and sold one year later for $84, what is the 1-year return?
- 4%
- 5% (correct)
- 3%
- 6%
Which of the following are special case patterns of dividend growth?
Which of the following are special case patterns of dividend growth?
- Zero growth (correct)
- Discounted growth
- Non-constant growth (correct)
- Negative growth
- Constant growth (correct)
- Fast growth
What information do we need to determine the value of a stock using the zero growth model?
What information do we need to determine the value of a stock using the zero growth model?
A zero-growth stock pays a dividend of $2 per share and has a discount rate of 10%. What will the stock's price be?
A zero-growth stock pays a dividend of $2 per share and has a discount rate of 10%. What will the stock's price be?
What is the formula for the present value of a growing perpetuity?
What is the formula for the present value of a growing perpetuity?
Suppose a firm's dividends are expected to grow at a rate of 15% for 3 years and then stabilize at 5%. If the firm just paid a $2.00 dividend and the discount rate is 10%, what is the value of a share in year 3?
Suppose a firm's dividends are expected to grow at a rate of 15% for 3 years and then stabilize at 5%. If the firm just paid a $2.00 dividend and the discount rate is 10%, what is the value of a share in year 3?
In the dividend discount model, the expected return for investors comes from which two sources?
In the dividend discount model, the expected return for investors comes from which two sources?
Which of the following are cash flows to investors from stocks?
Which of the following are cash flows to investors from stocks?
All else constant, the dividend yield will increase if the stock price:
All else constant, the dividend yield will increase if the stock price:
If the growth rate (g) is zero, the capital gains yield is:
If the growth rate (g) is zero, the capital gains yield is:
What is the total return for a stock that currently sells for $50, just paid a $1.75 dividend, and has a constant growth rate of 8%?
What is the total return for a stock that currently sells for $50, just paid a $1.75 dividend, and has a constant growth rate of 8%?
A benchmark PE ratio can be determined using:
A benchmark PE ratio can be determined using:
A PE ratio that is based on estimated future earnings is known as a PE ratio:
A PE ratio that is based on estimated future earnings is known as a PE ratio:
Using a benchmark PE ratio against current earnings yields a forecasted price called a price:
Using a benchmark PE ratio against current earnings yields a forecasted price called a price:
If Joan owns 100 shares of BC Company and the company is electing 4 directors, under cumulative voting, how many votes would she have?
If Joan owns 100 shares of BC Company and the company is electing 4 directors, under cumulative voting, how many votes would she have?
Preferred stock has preference over common stock in the:
Preferred stock has preference over common stock in the:
The trading of existing shares occurs in which market?
The trading of existing shares occurs in which market?
Which of the following defines the primary market?
Which of the following defines the primary market?
A person who brings buyers and sellers together is a:
A person who brings buyers and sellers together is a:
NYSE Designated Market Makers (DMMs) were formally called:
NYSE Designated Market Makers (DMMs) were formally called:
Inside quotes represent the _____ and the _____.
Inside quotes represent the _____ and the _____.
The NYSE differs from the NASDAQ primarily because the NYSE has:
The NYSE differs from the NASDAQ primarily because the NYSE has:
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Study Notes
Stock Valuation vs. Bond Valuation
- Valuing stocks is more complex due to unknown dividends, an unobservable required rate of return, and the absence of a maturity date.
Returns on Zero-Dividend Stocks
- A zero-dividend stock purchased for $80 and sold for $84 yields a 5% return, calculated as ($84/$80) - 1.
Patterns of Dividend Growth
- Key dividend growth patterns include non-constant growth, zero growth, and constant growth.
Zero Growth Model Requirements
- To determine stock value using the zero growth model, information needed includes the dividend amount and discount rate.
Pricing of Zero-Growth Stocks
- A zero-growth stock paying a $2 dividend with a 10% discount rate has a price of $20, calculated as $2/0.10.
Present Value of Growing Perpetuity Formula
- The formula for present value of a growing perpetuity is P = C / (R - g), where C = net cash flow, R = required return, g = growth rate.
Stock Value Calculation with Dividends
- For a firm with a 15% dividend growth for 3 years stabilizing at 5%, with a recent $2 dividend, the stock value in year 3 is $63.88, calculated through expected dividends.
Sources of Expected Return in Dividend Discount Model
- Expected returns for investors come from dividend yield and growth rate.
Investor Cash Flows from Stocks
- Cash flows to investors from stocks include dividends and capital gains.
Impact of Stock Price on Dividend Yield
- As stock prices decrease, the dividend yield will increase, all else being constant.
Capital Gains Yield and Growth Rate
- If the growth rate is zero, the capital gains yield is also zero.
Total Return Calculation
- A stock priced at $50, with a $1.75 dividend and 8% growth rate, has a total return of 11.78%, calculated using the dividend growth formula.
Benchmark PE Ratios
- Benchmark PE ratios can be deduced from the PE ratios of similar companies and a company's historical PE ratios.
Forward PE Ratio
- A forward PE ratio is based on estimated future earnings.
Target Price from PE Ratio
- Using a benchmark PE ratio against current earnings produces a target price for the stock.
Voting Power in Cumulative Voting
- Under cumulative voting, owning 100 shares allows for 400 votes when electing 4 directors (100 shares x 4 votes).
Preference of Preferred Stock
- Preferred stock takes precedence over common stock in dividend payments and distribution of corporate assets.
Secondary Market Trading
- Trading of existing shares occurs in the secondary market.
Primary Market Definition
- The primary market is where stocks are first issued to the public.
Role of a Broker
- A broker acts as an intermediary, bringing buyers and sellers together.
NYSE Designated Market Makers
- NYSE Designated Market Makers (DMMs) were originally known as specialists.
Inside Quotes
- Inside quotes refer to the highest bid price and the lowest ask price.
NYSE vs. NASDAQ
- A major difference between NYSE and NASDAQ is that NYSE has a physical trading location while NASDAQ operates as a digital platform.
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