FM2C (BSA-3)_ESAGA_SHIRLEY

1. Provide the definition of stocks.

A stock (also known as equity) is a security that represents the ownership of a fraction
of a corporation. This entitles the owner of the stock to a proportion of the corporation's
assets and profits equal to how much stock they own. Units of stock are called "shares."

Stocks are bought and sold predominantly on stock exchanges, though there can be
private sales as well, and is the foundation of many individual investors' portfolios.
These transactions have to conform to government regulations which are meant to
protect investors from fraudulent practices. Historically, they have outperformed most
other investments over the long run. These investments can be purchased from most
online stock brokers. Stock investment differs greatly from real estate investment.

2. What are the different types of stocks? Provide definition.

There are two main types of stocks: common stock and preferred stock.

Common Stock

Common stock is, well, common. When people talk about stocks in general they are
most likely referring to this type. In fact, the majority of stock issued is in this form. We
basically went over features of common stock in the last section. Common shares
represent ownership in a company and a claim (dividends) on a portion of profits.
Investors get one vote per share to elect the board members, who oversee the major
decisions made by management.

Over the long term, common stock, by means of capital growth, yields higher returns
than almost every other investment. This higher return comes at a cost since common
stocks entail the most risk. If a company goes bankrupt and liquidates, the common
shareholders will not receive money until the creditors, bondholders, and preferred
shareholders are paid.

Preferred Stock

Preferred stock represents some degree of ownership in a company but usually doesn't
come with the same voting rights. (This may vary depending on the company.) With
preferred shares investors are usually guaranteed a fixed dividend forever. This is
different than common stock, which has variable dividends that are never guaranteed.
Another advantage is that in the event of liquidation preferred shareholders are paid off
before the common shareholder (but still after debt holders). Preferred stock may also
be callable, meaning that the company has the option to purchase the shares from
shareholders at any time for any reason (usually for a premium).
Some people consider preferred stock to be more like debt than equity. A good way to
think of these kinds of shares is to see them as being in between bonds and common
shares. (If you don't understand bonds make sure also to check out our bond tutorial.)

3. What is the difference between stock price and intrinsic value? Why is do we
need to know the difference?

Stock price is generally driven by public, or external, opinions and expectations,

whereas intrinsic value is driven by private, or internal, opinions and expectations. A
company's financial goal is to maximize shareholder wealth, whether the company is
public or private. This wealth refers to intrinsic value because the market value may or
may not, at any given time, fully reflect a company's value. With private companies,
fewer people hold the shares, so the intrinsic value may be much higher than the
market value. A company can counter this when seeking additional investors by using
an investment bank or public relations firm to actively publicizing the company and its
achievements.

Stock price: current market price

Intrinsic value: represents the "true" value of the company's stock, can't be directly
observed and must instead be estimated

4. Why do investors and managers need to understand how to estimate a firm’s

intrinsic value?

When investing in common stock, one's goal is to purchase stocks that are undervalued
and avoid stocks that are overvalued. Managers need to know how alternative actions
are likely to affect stock prices. Second, they should consider whether their stock is
significantly undervalued or overvalued before making certain decisions.

5. What are two commonly used approaches for estimating a stock’s intrinsic
value? How do they differ in their focus?

Two commonly used approaches for estimating a stock's intrinsic value are the
discounted dividend model and the corporate valuation model. The dividend model
focuses on dividends, while the corporate model goes beyond dividends and focuses on
sales, costs, and free cash flows.