Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
30 Cards in this Set
- Front
- Back
"The value of any financial asset equals..."
|
The present value of all its future cash flows
|
|
What are the cashflows for a bond and stock valuation?
|
- Bond
Coupon + Face Value - Stock Dividend + Capital gains |
|
Why is common stock more difficult to value than a bond?
|
- There are no promised cash flows
- The life of the investment is forever, no maturity - The rate of return required by investors is unobservable |
|
If an investment will pay £2 in one year, and you believe you can then sell the stock for £10. What is the maximum you would pay if requiring a 20% rate of return? HOW TO FIGURE THIS OUT?
|
Price = (£10 + £2) / (1.2) = £10
|
|
If an expected return is £5 in a divident by year 5. Figuring out its present value would involve discounting this single cashflow by...
|
The power of 5 = 5 periods
|
|
The stock price today is equal to the present value of...
|
ALL future dividends.
|
|
The stock price does not depend....
|
on how long an investor intends to keep the stock, or how high the price might be in the distant future.
Stock price today = PV of all future dividends |
|
What is the discount rate used for stock valuation?
|
Required rate of return
|
|
What discount rate is used to value bonds?
|
YTM
|
|
It is implicitly assumed that firms...
|
Will not go bankrupt in the future.
|
|
Why are the stocks in companies which currently
pay no dividend traded at positive prices? |
The company might pay larger dividends every few years, using the money to reinvest, grow, and provide a larger return to investors in the long term.
This is favourable in some cases. |
|
Name the 3 types of dividend growth.
|
- Zero growth
- Constant growth - Supernormal growth (differential growth) |
|
What is constant dividend growth?
|
When firms will:
- Increase the dividend by a constant percent every period (like many mature companies) Use the Dividend growth model (goron growth model): p0 = D1 / (r-g) MULTIPLE PERIODS: Just compound D1 by growth rate. p4 = D1*(1+g) / (r-g) Constant growth model conditions: - Dividend expected to grow at g forever - Stock price expected to grow at g forever - Expected capital gains yield is constant and equal to g Expected total return = dividend yield + g |
|
What is dividend zero growth?
|
When firms will:
- Pay a constant dividend forever - Price is computed using the perpeturity formula p0 = D / r The price of a zero growth stock will NEVER CHANGE - unless the required rate of return changes. Since future cash flows are constant, the value of zero growth stock is the PV of a perpetuity. p0 = D/r THE PRICE OF A ZERO GROWTH STOCK WILL NEVER CHANGE, UNLESS THE REQUIRED RATE OF RETURN CHANGES. Therefore, there is no reason to expect capital gains from this stock. |
|
What is supernormal growth (differential growth)?
|
When firms will:
- Produce unconsistent dividend growth initially, but settles down to constant dividend growth eventually. - This is a variation of constant dividend growth |
|
If a question states "just paid", the dividend...
If a question states "expected to pay", the dividend... |
Just paid = extra cash early (like annuity due) = +1 period
Expected to pay = ordinary |
|
What is the main aim when finding the growth rate in Gordon's constant growth model?
|
Multiply out the brackets, and isolate numbers to one side, and g to another.
|
|
What is differential growth?
|
- Dividends grow at different rates and then will grow at a constant rate thereafter.
1) Calculate value when it starts paying dividends 2) Discount back to today. Always figure out the value for P one below d. Example: if trying to find value of d5, use p4. |
|
For stocks, how do you figure out the required return?
|
Required return = dividend yield + capital gains yield.
Dividend yield = (dividend income / stock price) Capital gains yield = (capital gains income) OR growth r |
|
What does common stock mean?
|
The stock has no special preference either in paying dividends or in bankruptcy.
Holders of common stock have shareholders voting rights -> Elect directors. |
|
What is proxy voting in common stock?
|
When stock owners transfer their vote to another party, in order to gain enough to affect important issues.
|
|
Do all shares give one vote?
|
Generally - however different classes of stock have different rights. Owners may issue nonvoting class of stock to make sure they maintain control.
|
|
Are dividends a liability of the firm?
|
No. A firm cannot go bankrupt for not declaring dividends.
|
|
How are dividends taxed?
|
Taxed as ordinary income for individuals.
Already gone through tax at a business level, through to profit, and then dividends. |
|
Name 3 features of preferred stock?
|
- Must be paid before common stockholders.
- Not a liability of the firm - Generally does not carry voting rights. |
|
Name two stock markets.
|
London Stock Exchange (LSE).
New York Stock Exchange (NYSE). |
|
What is dividend policy?
|
The decision to pay dividends now, or retain funds to reinvest.
|
|
Name 2 reasons why a low dividend payout is good.
|
1) Taxes - Higher tax bracket investors prefer capital gains, rather than low dividend payouts with their immediate tax consequences.
2) Flotation costs - Low payouts reduce the amount of capital that needs to be raised, lowering flotation costs (costs of issuing securities). |
|
Name 2 reasons why a high dividend payout is good.
|
1) Desire for current income - Regular usable cash.
2) Less risk that higher capital gains might not appear. Dividends become a significant part of ROI. |
|
Give 1 ad and disad of paying dividends?
|
1) Cash dividends underscore good results and support stock price.
2) Once established, making dividend cuts are hard without adversely affecting stock price. |