capitalmarketstest - -Malkiels model = should be willing to...

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-Malkiel’s model = should be willing to pay more for a stock the higher is the growth rate & longer it is expected to last –key to his rules hold if other things remain equal -if any new investment simply earns rate k, then growth is purely at the expense of dividends & does nothing for the shareholder – whether firm invests the funds for shareholder at rate k or shareholder gets dividends & invests elsewhere at rate k should have no impact on value -insights = excess profits add to value & growth adds to value only if accompanied by excess profits – model = limited in its assumption of a constant growth rate & constant profit rate – real world = expect high growth opps. are at some point exhausted & high profits might well be whittled away by entry -Malkiel’s four rules = security’s FF value & its PE multiple will be higher: the larger the companies growth rate & longer its duration; the larger the dividend payout ratio for the firm; the less risky the company’s stock; & the lower the general level of interest rates -risk is part of discount rate k, where k = risk free rate (rf) + equity premium € => good evidence that most investors are risk averse & would be willing to pay more for a less risky security, other things being equal -general level of interest rates also in k in rf – to some extent bonds & stocks = substitutes – if interest rate on bonds is lower, bonds less desirable & ppl willing to pay more for stocks -stocks & PE risk falling – bid up & high returns & high PEs – future = no g, lower div. yield & anticipated lower returns in fut. -maturity = # of years to the end of the bond, to the point where principle is to be repaid -duration = weighted avg. of years t until maturity, w/ weights being equal to the present value of the cash flows to be paid in each period – elasticity of bond to interest rate -modified duration = D’=D/(1+r) = used by bond traders to express impact on value of a change in interest rates of 100 basis points – higher MD = higher sensitivity -% change in value turns out to be slightly less than modified duration due to convexity of the bond – bond’s value falls w/ r at a decreasing rate, the impact of the finite change is a bit less than that implied by the derivative taken at the initial values
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This note was uploaded on 02/09/2012 for the course ECON 380 taught by Professor Petersen during the Spring '11 term at BC.

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capitalmarketstest - -Malkiels model = should be willing to...

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