Financial Markets (Bilingual Teaching)
Chapter 8 Stock Valuation and Risk
1. Stock Valuation Methods 1) Backgrouds:
? Stock price is determined by the demand and supply for the shares
? Investors try to value stocks and purchase those that are perceived to be undervalued by the market ? New information creates re-evaluation 2) Price-Earnings (PE) Method Firm’s Stock ratio Price
= Expected EPS ? Mean industry PE
3) Dividend Discount Method
DtPrice??t(1?k)t?1?Where k = discount rate, or Required Rate of Return 2. Determining the Required Rate of Return to Value Stocks 1) Capital Asset Pricing Model (CAPM)
? Used to estimate the required return on publicly traded stock
? Assumes that the only relevant risk is systematic (market) risk, Uses beta to measure risk rather than standard
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Financial Markets (Bilingual Teaching)
deviation of returns: Rj = Rf + ?j(Rm – Rf)
a) Estimating the risk-free rate and the market risk premium b) Proxy for risk-free rate is the yield on newly issued Treasury bonds
c) The market risk premium, or (Rm-Rf), can be estimated using a long-term average of historical data. 2) Arbitrage Pricing Model
? Differs from CAPM in that it suggests a stock’s price is influenced by a set of factors rather than just the return on the market
? Factors may include things like: d) Economic growth e) Inflation f) Industry effects
3. Factors that Affect Stock Prices 1) Economic factors
? Interest rates: Most of the significant stock market declines occurred when interest rates increased substantially
? Exchange rates: Foreign investors purchase U.S. stocks when dollar is weak or expected to appreciate; Stock
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Financial Markets (Bilingual Teaching)
prices of U.S. companies also affected by exchange rates 2) Market-related factors
? January effect: abnormal effect
? Noise trading: Trading by uninformed investors pushes stock price away from fundamental value 3) Firm-specific factors ? Expected +NPV investments ? Dividend policy changes ? Significant debt level changes ? Stock offerings and repurchases ? Earnings surprises
? Acquisitions and divestitures (剥夺，分拆) 4. analysts
1) Stock analysts interpret ―valuation effect‖ of new
information for investors; Analysts’ opinions impact stock buying/selling
2) Analyst may obtain ―new‖ information with company
executives in conference call
? Other investors are not privy to information
? Regulation FD (Fair Disclosure) from SEC requires ―release‖ of new significant information at the same time as teleconference calls with analysts.
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Financial Markets (Bilingual Teaching)
5. Measures of Stock Risk 1) Standard deviation or variance ? Market price volatility of stock a) Indicates a range of possible returns b) Positive and negative
c) Standard deviation (or variance) measure of variability ? Volatility of a stock portfolio depends upon: d) Volatility of individual stocks in the portfolio e) Correlation coefficients between stock returns f) Proportion of total funds invested in each stock 2) Beta
? Beta of a stock: Measures sensitivity of stock’s returns to market’s returns
? Beta of a stock portfolio: Weighted average of the betas of the stocks that comprise the portfolio, ?p = ?wi ?i 3) Value at Risk
? Estimates the largest expected loss to a particular investment position for a specified confidence level ? Warns investors about the potential maximum loss that they may incur with their investment portfolio ? Focuses on the ―loss‖ side of possible returns ? VaR can also used to measure the risk of a portfolio
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Financial Markets (Bilingual Teaching)
6. Stock Performance Measurement 1) Sharpe Index
? Assumes total variability is the appropriate measure of risk; A measure of reward relative to risk:
Sharpe Index ?2) Treynor Index
R-Rf?? Assumes that beta is the appropriate type of risk
? Higher the value; the higher the return relative to the risk-free rate:
Treynor Index ?R-Rf?7. Stock Market Forms of Efficiency 1) Weak-form efficiency
? Security prices reflect all historical price and volume information
? Implication: investors cannot earn abnormal returns based on past price movements 2) Semistrong-form efficiency
? Security prices reflect all public information 3) Strong-form efficiency
? Security prices reflect all information
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