Chapter 7

• is the principal medium through which corporation raise equity capital

  Common Stock
• those who hold stocks in a corporation, own an interest in a corporation equals to the percentage of outstanding shres they own

  Stockholders
• this ownership gives them bundle of rights

  Stockholder
• has the right to vote

  Stockholder
• residual claimant of all funds flowing into the firm

  Stockholder
• The stockholder receives whatever remains after all other claims against the firm's asset have been satisfied.
• A stockholder may received dividends from the net earnings of the corporation.
• are payments made periodically, usually every quater to stockholders

  Dividends
• The board of directors sets the level of dividends.
• a financial model that evaluates the value of an asset or investment over a single period of time

  One-Period Valuation Model
• you buy the stock, hold it for one period to get dividend, then sell the stock

  One-Period Valuation Model
• the current value of a stock can be calculated as the present value of the future dividend stream or cash


  The Generalized Dividend Valuation Model
• the price of stock is determined only by the present value of the dividends and that nothing else matters

  The Generalized Dividend Valuation Model
• Buyers of the stock expect that the firm will pay dividends someday.
• is the formula used to determine the intrinstic value of a stock based on a future series of dividends that grow at a constant rate

  The Gordon Growth Model
• Gordon Growth Model is useful for finding the value of stock:

  • Dividends are assume to continue growing at a constant rate forever
  • The growth rate is assumed to be less than required return on equity
• widely watched measure of how much the market is willing to pay for a dollar earning from a firm

  Price Earning Ration (PE)
• Implication of High Price Earning Ratio:

  • A higher PE may mean that the market expect earnings to rise in the future
  • A higher PE may alteratively indicate that the market feels the firm's earning are very low risk and is therefore willing to pay premium for them
• How Market set Stock Prices

  • the price is set by the buyers willing to buy the highest price
• How Market set Stock Prices

  • the market price will be set by the buyer who can take best advantage of the asset
• How Market set Stock Prices

  • superior information about an asset can increase its value by reducing its perceived risk
• How Market set Stock Prices

  • information is important for individuals to value each asset
• How Market set Stock Prices

  • when new information is released about a firm, expectations and prices change
• How Market set Stock Prices

  • market participants constantly received information and revise their expectations, so stocks price change frequently
• expectations will be identical to optimal forecast using all available information

  The Theory of Rational Expectations
• Even though a rational expectations equals the optimal forecast using all available information, a prediction based on it may be perfectly accurate.
• A forecast does not have to be perfectly accurate to be rational-it need only to be the best possible forecast given the available information; that is , it has no correction average.
• the expectation X equals the optimal forecast using all available information

  Formal Statement Theory
• Accurate expectations are desirable and there are strong incentives for people to try to make them equal to optimal forecast by using all available information.
• Implication of the Theory

  1. If there is a change in the way a variable moves, the way in which expectations of this are formed will change as well
  2. The forecast errors of expectations will, on average, be zero, and connot be predicted a head of time