1. 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

2. 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.

3. 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

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

5. 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

6. 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

7. 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.

8. 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.
McDonalds MCD –013

9. Other Approaches to Stock Valuation and Investing

10. 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

11. 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?

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