468-9 - Chapter 9 - STOCK MARKETS Transfer of funds from...

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Chapter 9 - STOCK MARKETS Transfer of funds from suppliers of funds (investors) to users of funds (firms), as one source of funds in addition to ______________ and _______________. Shareholders become owners and are entitled to dividends. See Figure 9-1 on p. 245, market value of stocks increased almost 3x from 1994 to 2004 to $15.6T. Shareholders are residual claimants , and have a claim on the residual income (dividends) and residual assets if firm's is liquidated or dissolved. Residual = left-over. Shareholders are owners, vs. bondholders (creditors, fixed return), and have voting rights to elect the board of directors. Secondary markets for stocks (NYSE, AMEX, NASDAQ) are closely watched daily. Reasons: a) stock price movements reflect current state of the economy, and predict future economic activity (leading indicator), and b) about 50% of U.S. individuals now own stock directly or indirectly (mutual funds, pension funds, retirement accounts). Stock Market Securities are either a) common stock or b) preferred stock. Stock return (or yield) is calculated as follows, from time period t (when you buy the stock) to time period t + 1 : 1. Capital Gain (Loss) as a %: (P t+1 - P t ) / P t , which is equal to ΔP / P t or the Change in Price, divided by the original price. 2. Dividend Yield (%): D t+1 / P t 3. Total % Return (R) : Capital Gain (%) + Dividend Yield (%). R = ΔP / P t + D t+1 / P t See Example 9-1 on p. 246. Example 3-10 from Appendix 3A: N I* PV PMT FV 2 (25) 1 35 Example 3-11 from Appendix 3A: N I* PV PMT FV 3 (32) 1.50 45 Stock price is equal the present value of future dividends (D): P = Σ D t / (1 + i ) t Issue: What assumption about future dividends? Several assumptions: BUS 468 / MGT 568FINANCIAL MARKETS: CH 9 Professor Mark J. Perry 1
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1. Zero Growth in Dividends : P 0 = D / i Example 3-12 in Appendix 3A: Assume D = $5 forever, and the expected rate of return is 12%. P = $5 / .12 = $41.67 2. Constant Growth in Dividends at a rate of g each year. P t = D 0 (1 + g) = D 1 or rearranging to solve for i : i - g i - g i = D 1 / P 0 + g Stock Return ( i ) = Div. Yield (D 1 /P 0 ) + Cap Gain ( g ) Examples 3-13 and 3-14 in Appendix 3A. 3. Supernormal Dividend Growth Suppose firm expects high growth period when dividends are growing at a supernormal growth rate ( g s , Period A), followed by a long period of dividends growing at at a normal rate ( g , Period B), e.g. new firm in a new industry like high-tech firms, e.g., Ebay, Yahoo, Microsoft, Sun, Intel, etc. or a company in an emerging market like China, Russia or India. 3 step process: 1. Calculate PV of dividends during supernormal period (A). 2. Calculate Price of stock during normal period (B), using constant growth model, discount to PV.
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This note was uploaded on 01/24/2012 for the course MGT 568 taught by Professor Staff during the Spring '11 term at University of Michigan.

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468-9 - Chapter 9 - STOCK MARKETS Transfer of funds from...

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