Financial Institutions and Markets-Day 8 W09

7/26/2019 Financial Institutions and Markets-Day 8 W09

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Financial InstitutionsFinancial Institutions

and Marketsand MarketsFIN 304FIN 304

Dr. Andrew L. H. ParkesDr. Andrew L. H. Parkes

Day 8Day 8How do fnancial markets work?How do fnancial markets work?


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Dec. 24, 2009 Fin Institutions & Markets 2

Ca!ter "0# $tocksCa!ter "0# $tocks

%e&e&'er te Di(idend )rowt%e&e&'er te Di(idend )rowtModel *)ordon )rowt Model+,Model *)ordon )rowt Model+,

Present -alue o a $tockPresent -alue o a $tock How to calculate teseHow to calculate tese /ats te (alue o stock i/ats te (alue o stock i

te co&!any 1oes 2ankru!t,te co&!any 1oes 2ankru!t,

/ALL $% 56$A

7%9997%999


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Di(idend 1rowt &odelDi(idend 1rowt &odel

6sin1 te &ulti!les o co&!ara'le6sin1 te &ulti!les o co&!ara'le

:r&s:r&s

Free cas ;ow &etod *co(ered in FinFree cas ;ow &etod *co(ered in Fin

"0


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=

ssss r

D

r

D

r

D

r

DP

1...

111

3

3

2

2

1

10

One whose dividends are expected togrow forever at a constant rate, g.

Stock Value = PV of Dividends

What is a constant growth stock?

Di(idendDi(idend 1rowt1rowt

&odel&odel


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As you know# or a constantAs you know# or a constant

1rowt stock=1rowt stock=

( )

( )

( ) t0t

202

101

g1DD

g1DD

g1DD

+=

+=

+=

gr

D

gr

gDP

ss

=

+

=

100

1

f g is constant, then!


6/34


D D gtt

= +"#

t

tt

r

DPVD

+

=

1

!Pr,>g 0 IfP PVDt"=

$

".%&

'ears (t)"


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/at a!!ens i 1 > r/at a!!ens i 1 > rss*k*kee+,+,

I rI rss? 1= 1et? 1= 1et ne1ati(ene1ati(e stock !rice= wic isstock !rice= wic isnonsense.nonsense.

/e cant use &odel unless *"+ 1


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Assu&eAssu&e'eta 'eta ".


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DD00was


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/ats te stocks &arket (alue,/ats te stocks &arket (alue,

DD00


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Dec. 24, 2009 Fin Institutions & Markets

/at is te stocks &arket (alue/at is te stocks &arket (alue

one year ro& now= Pone year ro& now= P"",,

DD""will a(e 'een !aid= so e@!ectedwill a(e 'een !aid= so e@!ected

di(idends are Ddi(idends are D


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Find te e@!ected di(idend yield andFind te e@!ected di(idend yield and

ca!ital 1ains yield durin1 te :rstca!ital 1ains yield durin1 te :rst

year.year.

Dividend


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otal return Di(idend yield otal return Di(idend yield

Ca!ital 1ains yield.Ca!ital 1ains yield.

otal return B G otal return B G "3."3.

otal return "3 rotal return "3 rss..

For constant 1rowt stock#For constant 1rowt stock# Ca!ital 1ains yield G 1Ca!ital 1ains yield G 1..

Find te total return durin1 te :rstFind te total return durin1 te :rst

year.year.


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*earrange /odel to rate of return for/!

.rto

0

1s

1

0 g

P

D

gr

DP

s

+

=

>hen, rs = $%.#%$2".%8 "."7= "."0 "."7 = #21.

;


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/at would P/at would P00'e i 1 0,'e i 1 0,

>he dividend strea/ would e aperpetuit

r

$%.""

".#2;


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I we a(e su!ernor&al 1rowt o 30I we a(e su!ernor&al 1rowt o 30

or 3 years= ten a lon15run constant 1or 3 years= ten a lon15run constant 1

G= wat is P G= wat is P00, r is still "3., r is still "3.

Can no lon1er use constant 1rowtCan no lon1er use constant 1rowt&odel.&odel.

Howe(er= 1rowt 'eco&esHowe(er= 1rowt 'eco&es constantconstantater 3 years.ater 3 years.

;


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@onconstant growth followed < constantgrowth!

"

%.2""8

%.750"

2."5&2

57.##2&

# % 2 5rs=#21

&5.#"70 = P"

g = 2"1 g = 2"1 g = 2"1 g = 71

D"= %."" %.7" 2.26 5.285 5.7&07

;&20#.77$

"7."#2."

7&07.5$PA

2 =

=


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/at is te e@!ected di(idend yield/at is te e@!ected di(idend yield

and ca!ital 1ains yield at t 0, Atand ca!ital 1ains yield at t 0, At

t 4,t 4,

Dividend


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Durin1 nonconstant 1rowt= di(idendDurin1 nonconstant 1rowt= di(idend

yield and ca!ital 1ains yield areyield and ca!ital 1ains yield are notnot

constantconstant.. I current 1rowt isI current 1rowt is1reater tan 11reater tan 1==

current ca!ital 1ains yield iscurrent ca!ital 1ains yield is 1reater1reater

tan 1tan 1..

Ater t 3= 1 constant G= so te tAter t 3= 1 constant G= so te t

4 ca!ital 1ains 1ains yield 4 ca!ital 1ains 1ains yield G.G.

2ecause r2ecause rss "3= te t 4 di(idend "3= te t 4 di(idendyield "3 5 G yield "3 5 G B.B.


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e current stock !rice ise current stock !rice is 4."".4."".

e P- o di(idends 'eyond year 3e P- o di(idends 'eyond year 3

isis 4G.""4G.""*P*P33 discounted 'ack to tdiscounted 'ack to t

0+. 0+.

e !ercenta1e o stock !rice duee !ercenta1e o stock !rice dueto lon15ter&J di(idends is#to lon15ter&J di(idends is#

!

= 6&.%1.$57.##

$&5.##

Is te stock !rice 'ased on sort5ter&Is te stock !rice 'ased on sort5ter&

1rowt,1rowt,


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$o&eti&es can1es in Euarterly$o&eti&es can1es in Euarterly

earnin1s are a si1nal o utureearnin1s are a si1nal o uture

can1es in cas ;ows. is wouldcan1es in cas ;ows. is would

aKect te current stock !rice.aKect te current stock !rice.

$o&eti&es &ana1ers a(e 'onuses$o&eti&es &ana1ers a(e 'onusestied to Euarterly earnin1s.tied to Euarterly earnin1s.

I &ost o a stocks (alue is due toI &ost o a stocks (alue is due to

lon15ter& cas ;ows= wy do solon15ter& cas ;ows= wy do so

&any &ana1ers ocus on Euarterly&any &ana1ers ocus on Euarterlyearnin1s,earnin1s,


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$u!!ose 1 0 or t " to 3= and$u!!ose 1 0 or t " to 3= and

ten 1 is a constant G. /at isten 1 is a constant G. /at is

PP00,,

"

#.0788#.&772#.267#

%".868&

# % 2 5

rs=#21

%&.0##6

g = "1 g = "1 g = "1 g = 71

%."" %."" %."" %.#%

%.#%

.P2 " "0

2".%6&0

;

...


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/at is di(idend yield and/at is di(idend yield and

ca!ital 1ains yield at t 0 andca!ital 1ains yield at t 0 and

at t 3,at t 3,

t = "!D#

P"

9' = #2."1 : 0.61 =&.%1.

%.""

$%&.0%0.61.

t = 2! @ow have constant growth

with g = capital gains


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I 1 I 1 5G5G= would anyone 'uy= would anyone 'uy

te stock, I so= at watte stock, I so= at wat

!rice,!rice,

+ir/ still has earnings and still pa


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/at are te annual/at are te annual

di(idenddi(idend

and ca!ital 1ains yield,and ca!ital 1ains yield,9apital gains


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Analysts oten use teAnalysts oten use te P &ulti!leP &ulti!le*te*te!rice !er sare di(ided 'y te earnin1s !er!rice !er sare di(ided 'y te earnin1s !ersare+ or tesare+ or te PCF &ulti!lePCF &ulti!le*!rice !er sare*!rice !er sare

di(ided 'y cas ;ow !er sare= wic is tedi(ided 'y cas ;ow !er sare= wic is teearnin1s !er sare !lus te di(idends !erearnin1s !er sare !lus te di(idends !ersare+ to (alue stocks.sare+ to (alue stocks.

@a&!le#@a&!le#

sti&ate te a(era1e P ratio o co&!ara'lesti&ate te a(era1e P ratio o co&!ara'le:r&s. is is te:r&s. is is te P &ulti!leP &ulti!le..

Multi!ly tisMulti!ly tis a(era1e P ratioa(era1e P ratio'y te'y te e@!ectede@!ectedearnin1s o te co&!anyearnin1s o te co&!anyto esti&ate its stockto esti&ate its stock!rice.!rice.

s n1 e oc r ceMulti!les to sti&ate $tockMulti!les to sti&ate $tock

PricePrice


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e entity (alue *-+ is#e entity (alue *-+ is# te &arket (alue o eEuity * sares o stockte &arket (alue o eEuity * sares o stock

&ulti!lied 'y te !rice !er sare+&ulti!lied 'y te !rice !er sare+

!lus te (alue o de't.!lus te (alue o de't. Pick a &easure= suc as 2IDA= $ales=Pick a &easure= suc as 2IDA= $ales=

Custo&ers= ye'alls= etc.Custo&ers= ye'alls= etc. Calculate te a(era1e entity ratio or aCalculate te a(era1e entity ratio or a

sa&!le o co&!ara'le :r&s. Forsa&!le o co&!ara'le :r&s. Fore@a&!le=e@a&!le= -2IDA-2IDA

-Custo&ers-Custo&ers

6sin1 ntity Multi!les6sin1 ntity Multi!les


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Find te entity (alue o te :r& inFind te entity (alue o te :r& inEuestion. For e@a&!le=Euestion. For e@a&!le= Multi!ly te :r&s sales 'y te -$alesMulti!ly te :r&s sales 'y te -$ales

&ulti!le.&ulti!le. Multi!ly te :r&s o custo&ers 'y teMulti!ly te :r&s o custo&ers 'y te-Custo&ers ratio-Custo&ers ratio

e result is te total (alue o te :r&.e result is te total (alue o te :r&.

$u'tract te :r&s de't to 1et te total$u'tract te :r&s de't to 1et te total(alue o eEuity.(alue o eEuity. Di(ide 'y te nu&'er o sares to 1et teDi(ide 'y te nu&'er o sares to 1et te

!rice !er sare.!rice !er sare.

6sin1 ntity Multi!les6sin1 ntity Multi!les

*Continued+*Continued+


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It is oten ard to :ndIt is oten ard to :nd co&!ara'leco&!ara'le:r&s.:r&s.

e a(era1e ratio or te sa&!le oe a(era1e ratio or te sa&!le o

co&!ara'le :r&s oten as a wide ran1e.co&!ara'le :r&s oten as a wide ran1e. For e@a&!le= te a(era1e P ratio &i1t 'e


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/y are stock !rices/y are stock !rices

(olatile,(olatile,

grD

"P

s

#

=

rs

= r*+

(*P-

)i

could change.

nflation expectations*isk aversion9o/pan< risk

g could change.

;


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/at is &arket eEuili'riu&,/at is &arket eEuili'riu&,

;

n eFuiliriu/, stock prices are stale.>here is no general tendenc< for

people to u< versus to sell.

>he expected price, P, /ust eFual theactual price, P. n other words, thefunda/ental value/ust e the sa/e asthe price.

(-oreC)


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n eFuiliriu/, expected returns /usteFual reFuired returns!

rs= D#P" g = rs= r*+ (r-: r*+).;

H i ili' iH i ili' i


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How is eEuili'riu&How is eEuili'riu&

esta'lised,esta'lised,

f rs= g rs, then P"is Gtoo low.H

f the price is lower than thefunda/ental value, then the stock is aGargain.H

Eu< orders will exceed sell orders, the

price will e id up, and D#P"falls until

D#P" g = rs= rs.

;

;

D#P"

;


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Dec 24 2009 Fin Institutions & Markets 34

Now take a look at O6%$9Now take a look at O6%$9

'ou will want to egin looking for a9hinese co/pan< to value as wellI

want

Documents

Financial Institutions and Markets-Day 8 W09