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Questions and Answers
What is the primary purpose of stock valuation?
What is the primary purpose of stock valuation?
Which of the following accurately describes the Dividend Discount Model (DDM)?
Which of the following accurately describes the Dividend Discount Model (DDM)?
What distinguishes relative stock valuation from absolute stock valuation?
What distinguishes relative stock valuation from absolute stock valuation?
What is meant by the term 'market value' of a stock?
What is meant by the term 'market value' of a stock?
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Which term refers to common stock issued by well-established companies?
Which term refers to common stock issued by well-established companies?
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What does the book value of a stock represent?
What does the book value of a stock represent?
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In the realm of stock valuation, what is the primary role of mutual funds?
In the realm of stock valuation, what is the primary role of mutual funds?
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What is an Exchange-Traded Fund (ETF)?
What is an Exchange-Traded Fund (ETF)?
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What does the dividend discount model primarily rely on to determine a company's stock price?
What does the dividend discount model primarily rely on to determine a company's stock price?
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Which advantage does the discounted cash flow (DCF) model have over the dividend discount model?
Which advantage does the discounted cash flow (DCF) model have over the dividend discount model?
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What does an intrinsic value greater than market price signify?
What does an intrinsic value greater than market price signify?
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Which of the following is considered a type of non-business risk?
Which of the following is considered a type of non-business risk?
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What is the primary concern of credit risk?
What is the primary concern of credit risk?
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In the context of price risk, what does this term specifically refer to?
In the context of price risk, what does this term specifically refer to?
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What does the comparable companies analysis method fundamentally focus on?
What does the comparable companies analysis method fundamentally focus on?
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Which of the following best describes business risk?
Which of the following best describes business risk?
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What does counterparty risk specifically pertain to in financial transactions?
What does counterparty risk specifically pertain to in financial transactions?
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What is meant by funding liquidity risk?
What is meant by funding liquidity risk?
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Which type of risk is associated with the fluctuations in exchange rates between the transaction date and the settlement date?
Which type of risk is associated with the fluctuations in exchange rates between the transaction date and the settlement date?
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What does concentration risk specifically pertain to?
What does concentration risk specifically pertain to?
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How is operational risk defined?
How is operational risk defined?
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What is public perception risk more commonly referred to as?
What is public perception risk more commonly referred to as?
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Which of the following describes systemic risk?
Which of the following describes systemic risk?
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What influences an investor's risk appetite?
What influences an investor's risk appetite?
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Study Notes
Stock Valuation
- Determining the intrinsic value of a stock or company shares.
- Mastering stock valuation is crucial for investors aiming to outperform the market.
- Intrinsic value may differ from the current market price.
- Understanding intrinsic value helps determine whether a stock is overvalued or undervalued.
Types of Stock Valuation
Absolute
- Relies on fundamental company information.
- Involves analyzing financial information from company statements.
- Includes techniques like Dividend Discount Model (DDM) and Discounted Cash Flow Model (DCF).
Relative
- Compares potential investments to similar companies.
- Calculates multiples of comparable companies and compares them to the target company.
- An example is comparable company analysis (trading comps).
Techniques in Stock Valuation
Dividend Discount Model (DDM)
- Assumes company dividends represent cash flows to shareholders.
- Intrinsic value equals the present value of future dividends.
- Applicable for companies with predictable and regular dividend distributions.
Discounted Cash Flow Model (DCF)
- Calculates intrinsic value by discounting free cash flows to present value.
- Advantage: No assumptions regarding dividend distribution.
- Suitable for companies with unknown or unpredictable dividends.
Comparable Companies Analysis
- A relative valuation method.
- Derives theoretical stock price using multiples of comparable companies.
- Does not rely on company fundamentals for intrinsic value.
Stocks
- Intrinsic Value: Perceived or calculated value based on fundamental analysis, considering financial health, earnings, dividends, growth rate, and other indicators.
- Market Price: Current price at which a stock can be bought or sold in the market.
Intrinsic Value vs. Market Price
- Intrinsic Value > Market Price = Undervalued
- Intrinsic Value < Market Price = Overvalued
Risk Management
- Accepting the potential for losses.
- Assessing the probability of adverse outcomes.
- Considering uncertainty regarding future outcomes.
Types of Risks
Business Risk
- Changes in demand.
- Fluctuations in input prices.
- Technological obsolescence.
Non-Business Risk
- Pandemics.
- Behavioral factors.
- Compliance issues.
Financial Risk
- Market movements (interest rate fluctuations).
- Currency and stock/share price fluctuations.
Types of Financial Risks
Market Risk
- Price Risk: Losses due to market price changes in financial instruments (stocks, bonds, commodities, currencies).
- Interest Rate Risk: Fluctuations in interest rates affecting fixed-income securities (bonds).
Credit Risk
- Default Risk: Borrower failing to repay loans or meet obligations, leading to lender losses.
- Counterparty Risk: Default by the other party in a financial transaction, especially in derivative contracts.
Liquidity Risk
- Asset Liquidity Risk: Assets cannot be sold quickly without significant price impact.
- Funding Liquidity Risk: Inability to meet short-term financial obligations.
Operational Risk
- Internal Factors: Inadequate processes, systems, people, or internal events.
- External Factors: Natural disasters, political instability, technological failures.
Currency Risk
- Transaction Risk: Fluctuations in exchange rates between transaction and settlement dates.
- Translation Risk: Converting financial statements to a different currency.
Commodity Price Risk
- Price Volatility: Fluctuations in commodity prices (oil, gas, metals, agricultural products).
Investment Risk
- Concentration Risk: Significant loss due to concentrated assets in a specific investment or sector.
- Managerial Risk: Investment performance affected by fund managers' decisions and competence.
Reputational Risk
- Public Perception: Negative publicity damaging company reputation, affecting market value and customer trust.
Regulatory and Legal Risk
- Compliance Risk: Legal or regulatory sanctions, financial loss, or reputational damage due to violations.
Systemic Risk
- Marketwide Risk: Industry or company event triggering severe instability or collapse of the financial system.
Managing Risks
- Risk Appetite: Broad description of risk acceptance levels for achieving investment goals.
- Risk Tolerance: Practical application of risk appetite, considering acceptable variability in returns.
- Age, income, and investment goals influence risk appetite.
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Description
Explore the essential techniques for determining the intrinsic value of stocks in this quiz. Master fundamental concepts such as Absolute and Relative valuation methods, along with specific techniques like Dividend Discount Model and Discounted Cash Flow Model. Gain insights into assessing whether a stock is overvalued or undervalued to enhance your investment strategy.