Lecture Slides.pptx

Core Module Financial Management (Week 9) The PowerPoint presentation was prepared by Dr Ahmed Saadi for the purpose of aiding London Professional Training’s students in developing financial management skills. They are to be used solely as the basis for class discussions. They are not intended to s...

Core Module Financial Management (Week 9) The PowerPoint presentation was prepared by Dr Ahmed Saadi for the purpose of aiding London Professional Training’s students in developing financial management skills. They are to be used solely as the basis for class discussions. They are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. PowerPoint© is a registered trademark of Microsoft Corporation. Wr i t e U p - We e k 8 Fe e d b a c k Write 250 words “ Part A – Explain how a stock market works and some of the risks involved in equity investments.“ Ta b l e o f C o n t e n t • Introduction to Stock Markets and Indices • What is a Stock Market? • What are Stock Indices? • Fundamentals of Stock Assessment • Exercises • Essay Writing • Summary Learning Outcomes • Understand the differences and functions of stock markets and indices. • Understand fundamental stock valuation methods like historical data, P/E and P/B ratios. • Calculate returns, estimate risk and determine covariance Understanding Stock Markets and Indices Understanding Stock Markets ─ We will explore stock markets, where companies sell shares and investors buy them, driving the financial world. ─ We will also dive into stock indices, which are like thermometers for the stock market, measuring its health by tracking groups of stocks. ─ We will cover understanding the difference between a stock market and a stock index, using the FTSE 100 and the London Stock Exchange (LSE) as examples. We will also touch upon basic methods for assessing stocks and the concept of investment portfolios. and Indices Exploring the Stock Market • A stock market is a hub where shares of public companies are bought and sold. It is a crucial part of our financial system, acting as a meeting place for investors and companies. • The stock market plays a pivotal role in the economy, reflecting its health and influencing growth. • Stocks are traded through exchanges, like the London Stock Exchange, facilitated by brokers who act as the middlemen. What are Stock Indices? • A stock index is a collection of stocks, representing a section of the market. It's used to track the overall performance of these stocks, giving us a quick snapshot of market trends. • Indices are important as they help investors compare the performance of individual stocks to the broader market. • For instance, the FTSE 100 index includes the top 100 companies on the London Stock Exchange, measured by market capitalisation. What Are Stocks? FTSE 100 vs London Stock Exchange • The London Stock Exchange (LSE) is a marketplace where stocks of companies are traded. • The FTSE 100, on the other hand, is an index representing the top 100 companies listed on the LSE, based on their market value. • So, while the LSE is a physical and virtual space for trading, the FTSE 100 is a metric indicating how well these top companies are performing. Methods to Assess Stock Investment Fundamentals of Stock Assessment To make smart investment decisions, it is crucial to assess stocks. One way is through historical financial data which gives insights into a company’s past performance. Historical Data to Assess Stocks Daily Stock Prices for top 10 companies on NASDAQ Historical Data to Assess Stocks Monthly Stock Returns of top 10 companies on NASDAQ 𝑀𝑜𝑛𝑡h𝑙𝑦 𝑅𝑒𝑡𝑢𝑟𝑛𝑠= 𝑃𝑡 − 𝑃𝑡 −1 𝑃 𝑡 −1 x 100 • - Closing Price current month​is the stock's closing price at the end of the current month. • - Closing Price previous month​is the stock's closing price at the end of the previous month. Monthly Returns of the Index (Market) Stock returns compared against the returns of the whole market. In this case is NASDAQ Other Stock Assessment Techniques Price-to-Earnings (P/E) Ratio P/E Ratio — Compares a company's current share price to its per-share earnings. A high P/E might suggest a stock is overvalued, or investors expect high growth. Example: If a company’s stock is priced at £100 and its earnings per share is £5, the P/E Ratio is 20. A higher P/E can indicate expectations of future growth. Price-to-Book (P/B) Ratio P/B Ratio — Compares the market value of a company’s stock to its book value. It can indicate whether a stock is undervalued or overvalued compared to its assets. Example: If a company’s book value is £50 per share and its stock price is £100, the P/B Ratio is 2. This can suggest whether a stock is undervalued (P/B<1) or overvalued (P/B>1) compared to its book value. Price-to-Book (P/B) Ratio Earning Per Share (EPS) — measures how much money a company makes for each share of its stock. A higher EPS often indicates a more profitable company. Example: If a company earns £1 million in profit and has 1 million shares, the EPS is £1. A rising EPS often signals increasing profitability. Additional Stock Assessment Techniques Market Capitalisation — It is the total value of a company's shares of stock. It helps categorise companies into different sizes like large-cap, midcap, and small-cap. Example: A company with 10 million shares priced at £10 each has a market cap of £100 million. Note: No single method can give the complete picture. It is best to use multiple methods for a well-rounded assessment. Exercise In-Class Exercise Let us consider a simplified scenario with two stocks over a period of five days. Assume we have Stock A and Stock B with the following closing prices over five days: Daily Prices of Stocks: • Day 1: Stock A - £100, Stock B - £ 200 • Day 2: Stock A - £ 102, Stock B - £ 202 • Day 3: Stock A - £ 101, Stock B - £ 204 • Day 4: Stock A - £ 104, Stock B - £ 207 • Day 5: Stock A - £ 103, Stock B - £ 210 Calculate stock returns, standard deviation (STD), variance, and covariance S t o c k Re t u rn s Let's calculate the daily returns for both stocks over the 5-day period The daily return = (Current Day Price−Previous Day Price)/Previous Day Price Stock A: • Day 2: (102−100)/100 = 0.02 or 2% • Day 3: (101−102)/102= −0.0098 or 0.98% • Day 4: (104−101)/101= 0.0297 or 2.97% • Day 5: (103−104)/104=−0.0096 or -0.96% Stock B: • Day 2: (202−200)/200 = 0.01 or 1% • Day 3: (204−202)/202 = 0.0099 or 0.99% • Day 4: (207−204)/204 = 0.0147 or 1.47% • Day 5: (210−207)/207 = 0.0145 or 1.45% Av e r a g e Re t u r n s The Average or mean value of the stock: • Stock A: Mean of 2%, -0.98%, 2.97%, -0.96% • Stock B: Mean of 1%, 0.99%, 1.47%, 1.45% Va r i a n c e Calculate the squared differences from the mean for each stock and then find the mean of these Stockvalues. A • • • • Squared Squared Squared Squared Difference Difference Difference Difference for for for for Day Day Day Day 2: 3: 4: 5: (0.02−0.00757)2 (−0.0098−0.00757)2 (0.0297−0.00757)2 (−0.0096−0.00757)2 Variance = ( (0.02 - 0.00757)^2 + (-0.0098 - 0.00757)^2 + (0.0297 - 0.00757)^2 + (-0.0096 - 0.00757)^2 ) / 4 = 0.031 This measure indicates the spread of Stock A's returns around its average return, reflecting its volatility. The higher the variance, the more the returns fluctuate over time. In this case, a variance of 0.031% suggests a moderate level of volatility in Stock A's returns over the observed period. Standard Deviation Standard deviation is the square root of the variance. It indicates the volatility of the stock. 2 𝑆𝑇𝐷=√ 𝑠 𝑋 Calculate the STD for Stock A and Stock B Covariance Covariance is the average product of the deviations of each stock's returns from their respective means. Day 2: • Deviation A: 0.02−0.0076 • Deviation B: 0.01−0.0123 Product: (0.02−0.0076)×(0.01−0.0123) Repeat this process for each day Add up the products obtained for each day. Divide the sum of products by the number of days The covariance between Stock A and Stock B, calculated step by step, is approximately 7.16×10−6 or 0.00000716. Interpretations • Stock A and Stock B have average daily returns of 0.76% and 1.23%, respectively. This suggests that Stock B, on average, yielded a higher return than Stock A over the period. • Stock A shows more volatility (higher standard deviation) compared to Stock B. This implies that Stock A’s price fluctuated more significantly than Stock B’s. • The positive covariance suggests that Stock A and Stock B tend to move in the same direction, but the low value of the covariance indicates that this relationship is relatively weak. • These calculations provide a basic understanding of the stock performance, their volatility, and how they move in relation to each other, which is crucial for portfolio management and investment strategies. Essay Write Up Wr i t e U p Write 500 words “ Part B – Collect, present, analyse and interpret company and share price data for four companies listed on the FTSE100 over a seven-week period, which falls within your module. This part should include a ‘Company Profile’ table which includes a summary of investor and financial information. “ Fu r t h e r Re a d i n g s Dyson, J.R., 2007. Accounting for non-accounting students. Pearson Education. Brealey, R.A., Myers, S.C. and Allen, F., 2020. Principles of corporate finance. McGraw-hill. Atrill, P. and McLaney, E.J., 2006. Accounting and Finance for Non-specialists. Pearson Education. Collis, J., Holt, A. and Hussey, R., 2017. Business accounting. Bloomsbury Publishing. Vernimmen, P., Quiry, P. and Le Fur, Y., 2022. Corporate finance: theory and practice. John Wiley & Sons.