1. Equity Security & Equity Markets
Chapter 8

2. Debt vs. Equity Debt: Equity: Contractual , obligation
The Issuer can be sued for default of payments
Equity:
Right to eliminate dividends, even on preferred shares
Can’t be sued for reduction or elimination of dividends

3. Equity Issue of shares is the result of incorporation
Originally - IPO (Initial public offering)
There are 2 general classes of corporate shares:
Preferred shares
Common shares

4. Equity Preferred shares: Common shares: Preferential dividends
Or liquidation treatment
Generally, voting right is suspended
Many offer a fixes Dividend per quarter indefinitely
Often cumulative
Common shares:
Residual claimants in the firm

5. Equity 4 dates associated with dividends:
Dividends – generally is the only direct payment between a firm and its shareholders.
4 dates associated with dividends:
Declaration date
Ex-dividend date
Record date
Payment date

6. Equity Valuation
Dividend Discount Model General case: D1 - forward (forecast) dividend in one period per share Can be = 0

7. Constant Growth DDM Also known as Gordon Growth Model (1962).
Appropriate for :
larger,
profitable,
mature,
dividend paying companies

8. Constant Growth DDM 1) 2) 3) r – Market Capitalization Rate (MCR)
g –growth rate, r > g 2)
- forward dividend yield 3)

9. Constant Growth DDM Retention ratio: Payout ratio: 4) Dividends
Earning
Dividends
Retained earning
Retention ratio:
generally: 0 ≤ b ≤ 1
Payout ratio: 4)

10. Constant Growth DDM Growth:
Almost all corporate characteristics grow at g:
Dividends
Earning
Book value of Asset (BVA)
Book value of Equity (BE)
Debt
Sales
Share price
The principal exception to this list is your Wealth.
the expected growth rate in your wealth per year per share – is expected ROR = r = MCR =D/P +g > g

11. Constant Growth DDM b, ROE - 2 determinant of growth 6) Recall:5)
- Sustainable growth
b, ROE - 2 determinant of growth
6) Recall:
- forward ROE per share

12. Constant Growth DDM
7) The price to forward Earnings Ratio: 8) Market to Book ratio:

13. Constant Growth DDM
9) Expected future corporate growth 10) Constant Growth Expected Return (CGER)

14. Constant Growth DDM Dividend Reinvestment with Constant Growth DDM
Received dividends are use to buy new shares.
Price that will be paid – Ex-dividend price at that time
Number of shares in dividend reinvestment plan in n years:

15. New Share Issue Public companies: Private companies:
General cash offer
Rights issue
Private companies:
New equity issue

16. New Share Issue Rights offering
In the rights offering the firm sells new shares to the existing shareholders (in the first instance).
Existing shareholders can maintain their fractional ownership if they increase $ investment or
they can sell their rights, then their fractional ownership falls & $ investment decreases.

17. Rights offering Characteristics:
1 right given by the firm per 1 share to existing shareholders (not sold) - Always
Often it takes more than 1 right to buy a new share & cash (primary market price)
You have this right (not the obligation) ~ 3 weeks (general)

18. Rights offering 3 important share prices:
P – original secondary market price
E – exercise price
– subscription price
- strike price
Ex – Ex-rights share price (share of old + new when they all are traded together) = new price& cash (primary market price)

19. Rights offering
You are not worse off as long as you do one of 2 things:
Sell rights (fractional ownership falls + $ investment falls):
Exercise the rights (maintain fractional ownership by increasing $ investment)

20. Rights offering Formula to relate the original price to the new price:
NR – number of Rights

21. The hypothesis of Capital Market Efficiency (CME)
(Informational Efficiency & Market Efficiency)
Definition:
Information is widely & cheaply available to all investors and
all relevant information is reflected in share price
Note:
CME is a hypothesis and not a statement of fact
The bulk of the empirical evidence is consistent rather than inconsistent with CME.

22. The hypothesis of Capital Market Efficiency
Two principal aspect of CME:
Hard to beat the “market”
Hard to do worse that the market
Conclusion:
Diversify
Do not overtrade