Chapter 13 Handouts

1. Systematic risk and unsystematic risk, diversification (Q13, Q14)

Systematic risk: (Can't have diversification / Cannot avoid risk) The market in
question has risk. Something like war and natural disasters are unavoidable
risks that affect the market. It hurts all stocks.

Unsystematic risk: (Can have diversification / Can avoid risk) Risks not
shared with the wider market. Something like a company cancelling one of
its products. It only hurts the one stock.

2. Beta and risk premium (Q10, Q12, Q15)

Beta risk: A measurement of market risk or volatility. That is, it indicates
how much the price of a stock tends to fluctuate up and down compared
to other stocks.

Risk Premium: refers to an excess return that investing in the stock

market provides at a risk-free rate. This excess return compensates
investors for taking on the relatively higher risk of equity investing.

3. Reward-to-risk Ratio, market equilibrium (Q9)

Reward-to-risk Ratio: The prospective reward an investor can earn for every
dollar they risk on an investment.
- divide your net profit (the reward) by the price of your maximum risk.
Market equilibrium: The state in which market supply and demand balance
each other, and as a result prices become stable.

4. Security Market Line, CAPM (Q9, Q10, Q11)

Security Market Line (SML): A line drawn on a chart that serves as a
graphical representation of the capital asset pricing model (CAPM)

Capital Asset Pricing Model (CAPM): A financial model that calculates the
expected rate of return for an asset or investment. CAPM does this by using
the expected return on both the market and a risk-free asset, and the asset's
correlation or sensitivity to the market.

Chapter 8 Handouts
1. Common stock vs preferred stock (Q1)
https://www.investopedia.com/articles/active-trading/101614/what-you-
need-know-about-preferred-stock.asp
Common Stock: You buy it, and you own that many shares. That is your
total cash value

Preferred stock: Your dividend stocks, that pay out dividends with set time
i.e., Quarterly, semi-annually

2. Stock market: NYSE vs NASDAQ, primary vs secondary (Q2, Q3, Q8)

In the primary market, companies sell new stocks and bonds to the public
for the first time, such as with an initial public offering (IPO). The secondary
market is basically the stock market and refers to the New York Stock
Exchange, the Nasdaq, and other exchanges worldwide.

3. Stock pricing: constant dividend model

➢ Suppose stock is expected to pay a $0.50 dividend every quarter and
the required return is 10% with quarterly compounding. What is the
price?
Dividend per stock / (Return % Time compounding)
.50 / (.1 / 4) = $20

4. Stock pricing: dividend growth model (Q4, Q5, Q6, Q7)

➢ Suppose Big D, Inc., just paid a dividend of $0.50 per share. It is
expected to increase its dividend by 2% per year. If the market
requires a return of 15% on the assets of this risk, how much should
the stock be selling for?
➢ Back out required return?
Solve:
Total dividend increase = Dividend per share (1 + Dividend Increase %)
.50(1+.02)
Required Return = (Return % - Dividend Increase %)
(.15 - .02)
How much does it sell for = Total Dvdnd Inc. / Req Return
.50(1+.02) / (.15 - .02) = $3.92
It sells for $3.92