Ch. 7: Equity Markets and Stock Valuation Common Stock Valuation Features of Common Stock Features of Preferred Stock Stock Markets Stock Listings Other Approaches to Valuation & Investing Mutual Funds, Index Investing, Foreign Investing

Common Stock Valuation In equilibrium, price = PV of expected cash flows. Expected cash flows = expected dividends + expected sale price of the stock. The sale price will depend on the buyer’s expected cash flows. “the current price of the stock can be written as the present value of the dividends beginning in one period and extending out forever.” (p. 185) Discount rate R comes from Security Market Line.

Dividend Growth Model a.k.a. Constant GM or Gordon Model If dividends grow at a constant rate g, and g < R, above model reduces to the Dividend Growth Model (p. 187): a.k.a. Constant GM or Gordon Model derivation is on webpage example solve for required return R R = Dividend yield + Capital gains yield

Extensions of Dividend Growth Model zero g nonconstant growth supernormal growth example declining growth example stocks that don’t pay dividends

Features of Common Stock ownership, no special preference in dividends or bankruptcy voting agency relationship (Ch. 1) secondary market value different classes, different rights dividends

Features of Preferred Stock hybrid of common stock and bonds payment priority over common, but usually nonvoting dividend, par, usually sinking fund usually dividends are fixed & cumulative, but not required, must be paid before common often convertible into common, often callable valuation: use Dividend Growth Model, g=0

Stock Markets Primary market, Secondary market Dealers Brokers NYSE Specialists Nasdaq Market Makers Listing requirements; OTC, Nasdaq, AMEX, NYSE, etc. Dow Jones Industrial Average, S&P 500, etc.

New York Stock Exchange Composite Transactions Reading Stock Listings THE WALL STREET JOURNAL Thurs., August 24, 2000 New York Stock Exchange Composite Transactions 52 Weeks Yld Vol Net Hi Lo Stock Sym Div % PE 100s Hi Lo Close Chg. 4956 2981 McDonalds MCD .20 .6 21 34133 3175 3094 3119 –013

Other Approaches to Stock Valuation and Investing

What Determines Expectations? equilibrium & CAPM changes in equilibrium macro factors inflation, interest rates, GDP growth & unemployment, exchange rates, monetary & fiscal policy, etc. micro factors management, products, forecasts, earnings, sector, competitors, merger/acquisition, etc. the special role of earnings

Interest Rates, Stock Prices, Bond Prices how do interest rates influence stocks & bonds? when might stock & bond price changes be positively-correlated? when might stock & bond price changes be negatively-correlated? when might their correlation be weak?

Mutual Funds and Index Investing Foreign Investing Currency (Foreign Exchange) & Country Risks Country Funds, American Depositary Receipts Recommended Practice Self-Test Problems 7.1 - 7.2, pp. 201-2 Questions 2, 3, 11 pp. 202-3 Problems on pp. 203-5: 1, 7, 13, 15, 17, 21, 23