Finance 300 Chapter 8 (Stock Valuation)

What are the three reasons why it is more difficult to evaluate stock than bonds? 1. With common stock, not even the promised cash flows are known in advance2. The life of the investment is essentially forever because common stock has no maturity3. There is no way to easily observe the rate of return that the market requires
A common stock with a constant rate of growth is also called what? Growing perpetuity
A model that determines the current price of a stock as its dividend next period divided by the discount rate less the dividend growth rate Dividend growth model
A stock’s expected cash dividend divided by its current priceConceptually similar to current yield on a bond Dividend yield
The dividend growth rate, or the rate at which the value of an investment growsThe rate at which the value of the investment grows Capital gains yield
How do you value stock if the company does not pay dividends? PE ratio, which is the stock’s price per share /// EPS
How do investors come up with a benchmark to use for PE ratios? 1. It could be based on similar companies (perhaps an industry average or median)2. Based on a company’s own historical values
A PE ratio that is based on estimated future earnings is called what? Forward PE ratio
How do investors value newer companies that don’t pay dividends and are not yet profitable, meaning their earnings are negative? You could use either a price-sales ratio
Equity without priority for dividends or in bankruptcy Common Stock
A procedure in which a shareholder may cast all votes for one member of the board of directorsTotal number of votes that each shareholder may cast is determined first. This is usually calculated as the number of shares (owner or controlled) * number of directors to be elected Cumulative Voting
READ In general, if there are N directors up for election, then 1 / (N + 1) percent of the stock plus one share will guarantee you a seat. ASSUMING CUMULATIVE VOTING
A procedure in which a shareholder may cast all votes for each member of the board of directorsThe only way to guarantee a seat is to own 50% plus one share Straight voting
What are the 2 effects of staggering your board of directors 1. Staggering makes it more difficult for a minority to elect a director because there are fewer directors to be elected at one time2. Staggering makes takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors
What beneficial purpose does staggering the board of directors provide? It provides “institutional memory” that is, continuity on the board of directors.
The grant of authority by a shareholder to someone else to vote his or her shares. For convenience, much of the voting in large public corporations is actually done this way Proxy
What is a primary reason for creating dual or multiple classes of stock? It has to do with control of the firm. If such stock exists, management of a firm can raise equity capital by issuing nonvoting or limited-voting stock while maintaining control
Other than voting rights, what are the other 4 rights that shareholder usually have? 1. The right to share proportionally in dividends paid2. The right to share proportionally in assets remaining after liabilities have been paid in a liquidation3. The right to vote on stockholder matters of great importance, such as a merger. Voting is usually done at the annual meeting or a special meeting4. The right to share proportionally in any new stock sold—the Preemptive right
Payments by a corporation to shareholders, made either in cash or stock Dividends
What are the 4 important characteristics of dividends? 1. Unless a dividend is declared by the board of directors of a corporation, it is not a liability of the corporation. A corporation cannot default on an undeclared dividend2. The payment of dividends by the corporation is not a business expense. Dividends are not deductible for corporate tax purposes. In short, dividends are paid out of the corporation’s aftertax profits3. Dividends received by individual shareholders are taxable. In 2014, the tax rate was 15%–20%, but this favorable rate may change. 4. Corporations that own stock in other corporations are permitted to exclude 70% of the dividend amounts they receive and are taxed on only the remaining 30%
Stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights Preferred stock
If preferred dividends are ______ and are not paid in a particular year, they will be carried forward as an arrearage. Usually, both the accumulated (past) preferred dividends and the current preferred dividends must be paid before the common shareholders can receive anything. Cumulative
What reasons make preferred stock seem to be a lot like a debt? 1. Preferred shareholder receive a stated dividend only2. If the corporation is liquidated, preferred shareholders get a stated value3. Often, preferred stocks carry credit ratings much like those of bonds4. Preferred stock is sometimes convertible into common stock or callable5. Many issues of preferred stock have obligatory sinking funds, which creates a final maturity because it means that the entire issue will ultimately be retired
READ In the 1990s, firms began to sell securities that looked a lot like preferred stocks but were treated as debt for tax purposes. The new securities were given interesting acronyms like TOPrS, MIPS, and QUIPS. Because of various specific features, these instruments can be counted as debt for tax purposes, making the interest payments tax deductible. Payments made to investors in these instruments can be counted as debt for tax purposes, making the interest payments tax deductible. Payments made to investors in these instruments are treated as interest for personal income taxes, and when the tax rate was reduced for dividends in 2013, these interest payments were not included
An agent who buys and sells securities from inventory Dealer
An agent who arranges security transactions among investors Brokers
How many seats, or, now, trading licenses are there on the NYSE 1,366
NYSE members who act as dealers in particular stocks. Formerly known as “specialists”These members continually make a two-sided market for their particular stock, continually posting and making updated bid and ask prices. This ensures that there is always a buyer or seller available, thereby promoting market liquidity Designated market makers (DMMs)
NYSE members who execute customer buy and sell orders, with an emphasis on getting the best price possible. These people are generally employees of large brokerage firms such as Merrill Lynch. They have a key interaction with DMMs to nonelectronic trading on the NYSE Floor brokers
Investment firms that are active participants in stocks assigned to them. Their job is to make a one-sided market (i.e., offering to either buy or sell). They trade purely for their own accountsThey are given a small rebate on their buys and sells, thereby encouraging them to be more aggressive Supplemental Liquidity Providers (SLPs)
Fundamentally, the business of the NYSE is to attract and process ____ ____, the flow of customer orders to buy and sell securities Order flow
What are the 2 distinct differences between the NASDAQ and NYSE 1. NASDAQ is a computer network and has no physical location where trading takes place2. NASDAQ has a multiple market maker system rather than a DMM system
Securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories Over-the-Counter Market (OTC)
What does level 1 of the NASDAQ do? Level 1 is designed to provide a timely, accurate source of price quotations, which are freely available over the internet.
What does level 2 of the NASDAQ do? Level 2 allows users to view price quotes from all NASDAQ market makers. In particular, this level allows access to inside quotes. These are now available on the internet, possibly for a small fee
What does Level 3 of the NASDAQ do? Level 3 is for the use of market makers only. This access level allows NASDAQ dealers to enter or change their price quote information. `
A website that allows investors to trade directly with each other. These opened up the NASDAQ by essentially allowing individual investors, not just market makers, to enter codes. Ultimately, increasing the liquidity and competition of the NASDAQ Electronic communications networks (ECNs)
On the NASDAQ ___ ____ are the highest bid quotes and the lowest ask quotes for a security. Inside quotes
In a constant growth dividend, holding all else equal, as the required rate increases what happens to the present value? Decreases

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