FI302 Exam 3 (Whaley Conceptual)
Study Guide.
Characteristics of a Stock
What do you own/entitled to? - Answer Major financing vehicle for corporations
◦ Provides holders with an opportunity to share in the future cash flows of the issuer.
◦ Holders have "ownership" in the company (residual claim on profit)
◦ Unlike bonds, no maturity date and variable periodic income
Stock Terminology - Answer Common stock
◦ First sold (initial public offering or IPO) in the primary markets
◦ Most investors trade stock in the secondary market
◦ Stocks may or may not issue a dividend (managerial decision)
◦ Frequently carry a voting right most notably regarding Board of Directors
Primary (IPO) vs Secondary Markets - Answer Primary (Initial Public Offering)- where the stock
is first sold
Secondary Market- where most investors trade stock
The primary market is where new securities are issued for the first time, while the secondary
market is where previously issued securities are traded between investors.
Dividend - Answer The portion of corporate profits paid out to stockholders
Voting Right - Answer A stockholder's right to vote for members Of the board of directors and
on matters of corporate policy—particularly the issuance of senior securities, stock splits and
substantial changes in the corporation's business. A variation of this right is extended to variable
annuity contract holders and mutual fund share- holders, who may vote on material policy
issues.
Bid vs Ask Price - Answer Bid Price: the prices at which investors are willing to buy shares
Ask Price: the price at which current shareholders are willing to sell their shares
Market vs limit orders - Answer Market orders execute a trade immediately at the best
available price, whereas a limit order only executes when the market trades at a certain prices
, How are orders filled? - Answer If the stock reaches the stop price, the order becomes a
market order and is filled at the next available market price. If the stock fails to reach the stop
price, the order isn't executed.
book vs market vs liquidation value - Answer Book Value- Net worth of the firm's equity
according to the balance sheet.
Market Value- Based upon current price of the security (stock)
Liquidation Value- Net proceeds that could be realized by selling the firm's assets and paying off
its creditors (debt holders)
-Value of Physical assets if the company were to go out of business and the assets sold.
What drives a wedge between market and book value - Answer 1. Extra earning power
2. Intangible assets
3. Future investments
Discounted Dividend Models (DDM) - Answer -Usually used when you plan to buy a stock,
hold it for one year, and then sell it at the end of that year. (SIMPLE DDM)
-If the stock reaches the stop price, the order becomes a market order and is filled at the next
available market price. If the stock fails to reach the stop price, the order isn't executed.
No Growth Model - Answer If we assume 1) we will hold the stock forever and 2) the company
issues all of it earnings as dividend (no growth), then the stock becomes a perpetuity. Preferred
shares can be valued in this way.
assumes that the dividend always stays the same, i.e., there is no growth in dividends.
Therefore, the stock price would be equal to the annual dividends divided by the required rate
of return. Stock's Intrinsic Value = Annual Dividends / Required Rate of Return.
Constant Dividend Growth (Gordon Model) - Answer The Gordon growth model attempts to
calculate the fair value of a stock irrespective of the prevailing market conditions and takes into
consideration the dividend payout factors and the market's expected returns. If the GGM value
is higher than the stock's current market price, then the stock is considered to be undervalued
and should be bought. Conversely, if the value is lower than the stock's current market price,
then the stock is considered to be overvalued and should be sold.
Non-Constant Dividend Growth - Answer segmenting the timeline into multiple annuities and
perpetuities and summing their respective present values.
Study Guide.
Characteristics of a Stock
What do you own/entitled to? - Answer Major financing vehicle for corporations
◦ Provides holders with an opportunity to share in the future cash flows of the issuer.
◦ Holders have "ownership" in the company (residual claim on profit)
◦ Unlike bonds, no maturity date and variable periodic income
Stock Terminology - Answer Common stock
◦ First sold (initial public offering or IPO) in the primary markets
◦ Most investors trade stock in the secondary market
◦ Stocks may or may not issue a dividend (managerial decision)
◦ Frequently carry a voting right most notably regarding Board of Directors
Primary (IPO) vs Secondary Markets - Answer Primary (Initial Public Offering)- where the stock
is first sold
Secondary Market- where most investors trade stock
The primary market is where new securities are issued for the first time, while the secondary
market is where previously issued securities are traded between investors.
Dividend - Answer The portion of corporate profits paid out to stockholders
Voting Right - Answer A stockholder's right to vote for members Of the board of directors and
on matters of corporate policy—particularly the issuance of senior securities, stock splits and
substantial changes in the corporation's business. A variation of this right is extended to variable
annuity contract holders and mutual fund share- holders, who may vote on material policy
issues.
Bid vs Ask Price - Answer Bid Price: the prices at which investors are willing to buy shares
Ask Price: the price at which current shareholders are willing to sell their shares
Market vs limit orders - Answer Market orders execute a trade immediately at the best
available price, whereas a limit order only executes when the market trades at a certain prices
, How are orders filled? - Answer If the stock reaches the stop price, the order becomes a
market order and is filled at the next available market price. If the stock fails to reach the stop
price, the order isn't executed.
book vs market vs liquidation value - Answer Book Value- Net worth of the firm's equity
according to the balance sheet.
Market Value- Based upon current price of the security (stock)
Liquidation Value- Net proceeds that could be realized by selling the firm's assets and paying off
its creditors (debt holders)
-Value of Physical assets if the company were to go out of business and the assets sold.
What drives a wedge between market and book value - Answer 1. Extra earning power
2. Intangible assets
3. Future investments
Discounted Dividend Models (DDM) - Answer -Usually used when you plan to buy a stock,
hold it for one year, and then sell it at the end of that year. (SIMPLE DDM)
-If the stock reaches the stop price, the order becomes a market order and is filled at the next
available market price. If the stock fails to reach the stop price, the order isn't executed.
No Growth Model - Answer If we assume 1) we will hold the stock forever and 2) the company
issues all of it earnings as dividend (no growth), then the stock becomes a perpetuity. Preferred
shares can be valued in this way.
assumes that the dividend always stays the same, i.e., there is no growth in dividends.
Therefore, the stock price would be equal to the annual dividends divided by the required rate
of return. Stock's Intrinsic Value = Annual Dividends / Required Rate of Return.
Constant Dividend Growth (Gordon Model) - Answer The Gordon growth model attempts to
calculate the fair value of a stock irrespective of the prevailing market conditions and takes into
consideration the dividend payout factors and the market's expected returns. If the GGM value
is higher than the stock's current market price, then the stock is considered to be undervalued
and should be bought. Conversely, if the value is lower than the stock's current market price,
then the stock is considered to be overvalued and should be sold.
Non-Constant Dividend Growth - Answer segmenting the timeline into multiple annuities and
perpetuities and summing their respective present values.
