Introduction to Stock Markets and Securities

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Questions and Answers

What does the intrinsic value of a stock represent?

The value of the stock based on historical performance

The future market price of the stock

The present value of expected future cash flows (correct)

The potential dividends paid in the past

If expected dividends are $3 per share and the expected price in 1 year is $81 per share, what is the intrinsic value assuming a discount rate of 12%?

$72.32

$78.57

$75.00 (correct)

$80.00

In the Dividend Discount Model, what does P0 represent?

The present value of all expected future dividends (correct)

The immediate cash dividend received

The price of the stock in the future

The total market capitalization of the stock

How is the expected return defined in the context of stock valuation?

The total yield from dividends and capital gains Signup and view all the answers

What is the role of the discount rate in stock valuation?

It helps in calculating the present value of future cash flows Signup and view all the answers

If you expect to receive dividends of $3.00, $3.24, and $3.50 over the next three years, along with a market price of $94.48, what is required to calculate the stock price?

The appropriate discount rate for present value calculation Signup and view all the answers

What would be the effect of increasing the discount rate on the intrinsic value of a stock?

It would decrease the intrinsic value Signup and view all the answers

Which formula best describes the intrinsic value calculation for a stock?

$rac{Div1 + P1}{1 + r}$ Signup and view all the answers

What is the expected dividend yield in the given example?

4% Signup and view all the answers

In the expected return formula, what does the term 'P1 - P0' represent?

Capital gain Signup and view all the answers

According to Random Walk Theory, how do security prices change?

Randomly with no trends Signup and view all the answers

What do technical analysts primarily focus on to forecast stock prices?

Past stock price patterns Signup and view all the answers

What is the expected capital gain from the example given?

8% Signup and view all the answers

Which type of analysis involves looking at accounting data and business prospects to find mispriced securities?

Fundamental Analysis Signup and view all the answers

What does the term 'npv' in fundamental analysis mean?

Net present value Signup and view all the answers

What is the combined expected return formula made up of?

Dividend yield + Capital appreciation Signup and view all the answers

Which term describes the first offering of stock to the general public?

Initial Public Offering (IPO) Signup and view all the answers

What is the market called where previously issued securities are traded among investors?

Secondary Market Signup and view all the answers

Which ratio compares the stock price to earnings per share?

P/E Ratio Signup and view all the answers

What does a dividend represent in the context of stocks?

A periodic cash distribution to shareholders Signup and view all the answers

If the ask price for a stock is $200, what does this price represent?

The price at which current shareholders want to sell the stock Signup and view all the answers

When purchasing 100 shares of a stock at an ask price of $167.43, what is the total expected cost?

$16,743.00 Signup and view all the answers

Which of the following best describes common stock?

Ownership shares in a publicly held corporation Signup and view all the answers

What is the significance of the bid price in stock trading?

It shows the price at which investors are willing to buy shares Signup and view all the answers

What is the formula for valuing a stock that is expected to have no growth and be held indefinitely?

P0 = Div1 / r Signup and view all the answers

If a stock is expected to pay a dividend of $0.86 next year and dividends grow at 4.75% with a required return of 7.0%, what is the value of the stock?

$38.22 Signup and view all the answers

What does the Payout Ratio represent?

Fraction of earnings paid out as dividends Signup and view all the answers

In the context of dividend growth models, the variable 'g' represents what?

The rate of growth of dividends Signup and view all the answers

Which of the following statements about stock dividends is true?

Lower dividends may result in higher future dividends. Signup and view all the answers

What is the expected return if the stock price is $38.22, the dividend next year is $0.86, and the growth rate is 4.75%?

7.0% Signup and view all the answers

Which of the following correctly describes the term 'Plowback Ratio'?

Fraction of earnings retained by the firm Signup and view all the answers

If dividends grow at a constant rate, which approach is used to assess the stock price?

Dividend Growth Model Signup and view all the answers

What is the value of the stock before the plowback decision?

$41.67 Signup and view all the answers

What is the expected growth rate after the plowback decision based on the company's ROE and plowback ratio?

0.08 Signup and view all the answers

What is the Present Value of Growth Opportunities (PVGO) when comparing stock prices before and after the plowback?

$33.33 Signup and view all the answers

If the company decides not to plowback any earnings, what would happen to the stock price?

It would remain constant at $41.67. Signup and view all the answers

What is the formula used to calculate the present value in a non-constant growth scenario?

$PV = rac{Div1}{(1+r)} + rac{Div2}{(1+r)^2} + rac{PH}{(1+r)^H}$ Signup and view all the answers

What is the growth rate assumed to begin in year 6 of the given example?

6% Signup and view all the answers

What is the total amount of dividends paid in year 4 based on the example provided?

$2.87 Signup and view all the answers

What would the stock price be with growth after the plowback decision?

$75.00 Signup and view all the answers

Study Notes

Primary Market

Corporations issue new securities for sale
Initial Public Offering (IPO) is the first time shares are offered publicly
Corporations sell shares in their business, raising capital

Common Stock

Ownership shares in a publicly held corporation
Secondary Market is where previously issued securities are traded among investors
Dividends are periodic cash distributions from the company to shareholders
P/E Ratio compares the stock price to the company's earnings per share

Bid and Ask Prices

Bid Price is what investors are willing to pay for shares
Ask Price is what current shareholders are willing to sell their shares for

Intrinsic Value Method

Uses discounted cash flow model
Predicts the intrinsic value of a company based on future dividends and expected price in a year

Dividend Discount Model

States the current stock price equals the present value of all anticipated future dividends
Model takes into account dividends, discount rate, and time horizon of investment

Simplifying the Dividend Discount Model

Perpetuity assumes no growth and indefinite stock holding
Constant-Growth DDM is a version of the dividend growth model with a constant growth rate
Plowback Ratio is the percentage of earnings retained by the company
Sustainable Growth Rate is a measure of how much a company can grow organically
Present Value of Growth Opportunities (PVGO) is the difference between the stock price with and without earnings plowback

Valuing Non-Constant Growth

Calculates the present value of dividends over a period with non-constant growth

Expected Return

Can be broken down into dividend yield and capital appreciation
Dividend yield is the annual dividend divided by the stock price
Capital appreciation is the expected growth in stock price

Technical Analysts

Search for patterns in historical stock prices to identify undervalued securities
Forecast stock prices based on past price fluctuations

Random walk theory

Security prices are unpredictable and fluctuate randomly
Movement of stock prices is random

Fundamental Analysts

Analyze fundamental information (accounting data, business prospects) to identify mispriced securities
Research the value of stocks using Net Present Value (NPV) and other cash flow measurements

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Description

Explore the fundamentals of the primary market, common stock, and essential trading concepts like bid and ask prices. Learn about valuation methods such as the Intrinsic Value Method and the Dividend Discount Model, essential for understanding stock pricing. This quiz is perfect for students seeking to enhance their knowledge of financial markets.