m3l8 - Fall 2010 Module 3 Accounting & Finance Lecture...

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David Robinson © D. Robinson, 2010 Fall 2010 Module 3 Lecture 8: Stocks, Portfolios, Mutual Funds & ETFs
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Accounting Managerial Financial Finance Auditing How investors use their money How firms raise money Three financial statements Forms of business Income St. Balance Sheet St. Cash Flows
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Lecture Outline • Valuing Common Stocks • The daily battle between greed and fear ong n valuation of future cash flows • Long-run valuation of future cash flows • Price/Earnings ratio handles different stock prices, different earnings • Diversification • Unique risk versus Market risk • Portfolios
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Common Stock (“shares”) • A fraction of ownership in a company • You can buy and sell at any time ompany never expects to pay you back the • Company never expects to pay you back the original money • Company _may_ give dividends (a small payment—part of the profits—typically once a year
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Common Stocks are Risky • But, over long periods of time they give a better return than “fixed instruments” (i.e. bonds) • Their rising prices reflect the growing economy
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Why do People Invest in Common Stocks ?
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All investors want a “good return” • Interest rates on Savings Accounts at Banks are very low—about 1 percent Total return: Price + dividends • Wouldn’t even keep up with inflation
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Market has climbed out of a big sell-off last year: Peak 14,000 Oct 2007 Low 1 early 2009, about 6,500
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Definition: “Bear Market” • A severe moderate-term decline in share prices • The drop in prices causes a loss of investor confidence • Many shareholders sell, decreasing prices further
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Over the long run, the market has returned 10.5 to 11 percent Total return: Price + dividends That beats “safe” bonds, say 4 to 5 percent Logarithmic scale
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Valuing Common Stocks Common stocks produce a variable return
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Common Stock is even more risky than a corporate bond • We hope to get a bigger return, • But • Dividends are not guaranteed • If the company fails (goes bankrupt) we’ll likely get nothing at all • [Bond holders (owners) are creditors of the firm and get paid in full before shareholders get what’s left.]
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Where do stock prices come from ? • Book value? (Not likely)
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m3l8 - Fall 2010 Module 3 Accounting & Finance Lecture...

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