VII

VI STOCK
V
VALUATIO
IV MAS 2
Financial Markets N
III BSA - 2A

II
I
VII Equity
VI Instrument
V
IV
III
II COMMON
STOCK
PREFERRENCE
STOCKS
I
Learning Goals
VII Equity
VI Market
V
IV
III
Primary Secondary II
Market Market I
Learning Goals
VII Equity
VI Transactions
V
IV
Bid Ask Spread
Placing Order III
Margin Trading
Short Selling II
Stock trading
regulations
I
Learning Goals
 Stock Indicators
VII Indexes
Market Indicators

VI Execution Cost

V
IV
Equity
Characteristics III
II
I
Learning Goals
VII
VI Valuation
Method V
Fundamental
IV
Analysis
III
Technical Analysis
II
I
Learning Goals
VII Factors & Risk
of Stocks VI
V
IV
III
Affecting II
Stock Prices I
Learning Goals
 Variable VII
-Growth
VI
Constan
t- V
Growth
Zero-
IV
Growt
h
Concept of III
Market Efficiency II
& Basic Stock I
Learning Goals
 EQUITY
INSTRUMENTS
Turato, Ella Mae
 DEBT or
EQUITY?
If the financing instrument

contains an obligation

to repay money in the future

 DEBT or EQUITY?
No promise of repaying money in the future

but a promise

to share earning
What are equity securities?

FIR Raise
funds
M
 What are equity securities?
INVESTO Means holding
RS wealth
 What are equity securities?
INVESTO Means holding
RS wealth
 What are equity securities?
INVESTO Means holding
RS wealth
 What are equity securities?
INVESTO Means holding
RS wealth
 Share of profits from the
company

DIVIDEN
DS
DIFFERENT EQUITY
INSTRUMENTS
Common
Shares
Preference
Shares
Private
Equity
Global
Shares
COMMON SHARES
Equity
ownership in Voting
a rights
corporation

Capital
Dividends appreciati
on
PREFERENCE
SHARES
Enables a shareholder with a right to
obtain regular dividends from the
company

Regular
Dividends
intervals
 PREFERENCE
SHARES
Varieties of Innovations in Preference
Shares:
Cumulative Preferred shares

Carries forward unpaid dividends

next year
Non-cumulative Preferred shares

Do not pay any missed past

dividends
 PREFERENCE
SHARES
Varieties of Innovations in Preference
Shares:
Redeemable Preferred Shares
Has a maturity date on which the
original sum invested is repaid
Convertible Preferred shares
Convert preference shares into
ordinary shares at a predetermined
rate
 PREFERENCE
SHARES
Varieties of Innovations in Preference
Shares:
Participating Preferred shares
Allows issuing company to increase the
dividends if profits are high
Stepped Preferred shares
Pay a dividend that increases in a
predetermined way
PRIVATE EQUITY
Investment funds that buy shares in
the company that are not publicly
traded in order to restructure it

Private Not listed

companie on stock
s exchanges
 PRIVATE EQUITY
The most important sources of
private equity investments come
from:

Venture Capital Private Equity Leveraged

Funds Funds Buyouts
 Venture Capital
Funds
Receive capital from wealthy
individuals or institutional investors to
maintain the investment for

5 10
 Private Equity
Funds
Pool resources of their
partners to fund most often
new business start-ups
Acquires all
Change EXIT
shares
management

Improve financial
De list it
performance
Leveraged
Buyouts
Are company equity purchases by
individual or institutional investors,
which are financed by :

D
Y
E EQUIT
B
T
GLOBAL SHARES
Investors may invest into foreign
shares by purchasing directly:

American Global
Depository Depository
Receipts Receipts
International Mutual Funds
(IMFs)
Investing into a portfolio of
international securities, created
and managed by various financial
institutions
Exchange Traded Funds (ETFs)
Passive funds, that track specific
index
American Depository Receipt

Certificate of ownership issued by US

Bank to promote local trading on a
foreign stock
American Depository Receipt

Advantages Vs. Disadvantages

+easy and direct access +costly investment

to foreign markets
+difference in price and
+building company name in returns
recognition in the foreign
country +Market for ADRs can be
illiquid
+reliable quoting of
share price
Global Depository Receipt
(GDRs)
Are negotiable receipts issued by
financial institutions in developed
countries against shares of foreign
companies
EQUITY
MARKET

Dantes, JP
 Equity
MarketsMarket
which organize trading
nationally and internationally in
such instruments, as common
equity, preferred shares, as well
as derivatives on equity
instruments.
Primary Secondary
Market Market
 Primary
Market
New Stock Market where
Issuance newly formed
securities are to be
STOCK sold
AND
ISSUER BONDS INVESTOR
FIRST - Investment
Directly
AVAILABL banks
I-NITIAL to
E - Endowments
P-UBLIC - Mutual funds
O-FFERING - Hedge Funds
- Pension Funds
1 Private 2 Public
Placement Market
Not registered in Market
Underwriting of
SEC securities
Not listed in the Listed in the stock
stock exchange exchange
Unquoted shares
PRIMARY Quoted shares
MARKET
PRIMARY PUBLIC
MARKET Seasoned Equity
Initial Public Offering (SEO)
Offering (IPO) or Secondary
Public Offering
Company
(SPO) is
Process by which
already listed and
old or new
issued additional
company decided Change existing
shares
to be listed their shares for quoted
stocks on stock ones
market
Process of going public

Develop
Prospectus

SEC

Road Show
 Investment Bank
Act of
guaranteeing a
To specific price to
underwrite the issuer of the
securitybank
Investment
Lead that are required
Underwriter to underwrite a
portion of newly
Book issued
 Pecking order
theory
Hierarchy of financial preference

Internal

Externa
l
debt
funding
 Pecking Order Theory
Investor Sentiment

Overall attitude of
investor
Risk aversion

Increase the cost of equity

issuance
Preventing companies issue new
shares
Advantage of
IPO
ability to raise capital quickly
Increase recognition of the
company name
Improve company transparency
motivator for some companies
Possibility to diversify investment
Increase financial independence
Disadvantage
of IPO
High issuance cost due to underwriters
High cost on disclosure requirements
Separation of ownership and control(agency
problem)
Companies is pressured
Sacrifice long term growth for short term
growth
 Abuse in the IPO
Spinning Market:
is the act or practice of an investment bank
offering under-priced shares of a company's
Ladderinginitial public offerings
A practice of initial public offering (IPO)
underwriters that requires investors to buy
shares at higher prices
Excessive Commissions-When
the brokerage or underwriting firm demands
excessive or unlawful brokerage commissions in
return for IPO allocations.
 Secondary
market
Equity securities
traded among investor
Effective secondary
market is an important
basis of successful
primary market
 SECONDARY
EQUITY
MARKET
Organized Over the
Stock Counter
Exchanges Market
Organized Stock
Exchange
Stock Exchanges- central trading
locations, in which securities are
traded
Trading List- instrument that
satisfies the requirements set by the
exchange
 Advantage
of Listing
Ability to sell on the stock
exchange Disadvant
It provides market price for the
shares
age of
Increase transparency Listing
Basis for valuation of companyCostly for the company
Requires substantial amount
of document to be preferred
Increase transparency which
may cause competition and
in takeover cases
 An agent who buys and
sells securities as a
principal on its own

vs.
DEALERS account

An agent who execute

BROKERS

orders to buy and sell

securities on behalf of
their clients.
Stock Market
Members
Commission Issuing Intermediary
Broker
Odd-Lot Broker Market Maker
Registered Trader Arbitrageur
Specialist Hedger
Commission Broker

sell orders fexecute buy and or

the public for fee
Odd-Lot Broker
Execute transaction of fewer
than 100 shares
Registered Trader

Who owns a seat on a stock

exchange and trade on his own
account
 Specialist

Market maker for individual

securities listed on a organized
Issuing Intermediaries stock exchange

acts as the middleman

between two parties
Market Makers

intermediaries who hold securities

and quoted a price
Arbitrageur

buys and sells financial assets

in order to make profit in pricing
anomalies

Hedger

buy and sell commodity

 OVER THE
COUNTER
MARKET
A market for securities made up of
dealers. It is not an organized
exchange, and trading usually take
place by electronic means
 OVER THE COUNTER
MARKET
Highly
Unorganize
Organized
d OTC
OTC
Markets
Markets
Unorganized OTC
Markets
Markets with
unregulated trading
take place between
individuals
Highly Organized
OTC Markets
Specializing in trading
specific company
shares
 ELECTRONIC
STOCK MARKET
Created for disclosing and executing
stock transactions electronically

Electronic Communication Network

 Direct trading of stock between
2 customers without the use of
brokers
ALTERNATIVE TRADING
SYSTEM

Crossing
Dark pools
network
 Crossing
Dark Pools
Network
Marketinin
Market
which
which Perform a traditional
Perform a traditional
anonymously
anonymously roleofofstock
role stockexchange
exchange
matchedatat
matched
specified time
specified time
Low
Low Preventinformation
Prevent information
transaction
transaction leakage
leakage
costs
costs
Program
Trading
Simultaneous buying and selling
of a large portfolios of high rated
stock with significant aggregate
Refers
value to the use of computer
system
 Secondary Equity
Market Structure
Based on trading
procedures:

Cash Continuo Auctio Order- Quoted-

Forward
Market Markets
us n driven driven
s Market Market Market Market
 Cash Forward
Markets Markets
Marketswhere
Markets where
Periodic
Periodic
stocks
stocks areare
settlement
settlement
tradedinincash
traded cash
system
system
basis
basis
Typicallyinin33
Typically Pricesare
Prices arefixed
fixed
daysperiod
days period
after atatthe
thetime
timeofof
after transaction
transaction transaction
transaction
Continuous Auction
markets Markets
Market in
Market in
whichthe
which the
Transactions
Transactions supplyand
supply and
takesplace
takes placeall
all demandofof
demand
day
day securitiesare
securities are
matched
matched
Marketmakers
Market makers directly
areensuring
ensuring Price isisformed
Price
directlyformed
are asanan
market as
market equilibrium
liquidityatat equilibrium
liquidity price
moment price
moment
Order-driven Quote-driven
Markets Markets
Market in
Market in
whichdealer
which dealer
Markets
Markets adjusttheir
adjust their
withoutactive
without active quotes
quotes
marketmakers
market makers continuouslytoto
continuously
reflect supply
reflect supply
Buyand
andsell
sell anddemand
and demand
Buy Alsocalled
called
ordersdirectly
directly Also
orders price-driven
confronteach
each price-driven
confront market
other market
other
 Equity
Transactions

Abas, Harry
 OVERWIEW
Bid Ask Spread
Placing Order
Margin Trading
Short Selling
Stock trading
regulations
Price taker – a person or
company that has no control
to dictate a price.
Market Maker – a company or
individual that quotes both
buy and sell price in financial
instrument.
Ask price – the price at which market
maker is willing to sell a security
( Offer price)

Bid price – the price at which market

maker is willing to buy a security

Ask price > Bid price

 Spread = Ask price – Bid price

Bid ask spread – A dealer's

compensation for his cost and risk
(Dealer's Perspective).

Price need to be paid for the service of the

dealer (Investors perspective).
1 Bid ask spread
Factors Influencing
Spread
Order Cost
Inventory Cost
Completion
Volume
Risk
Dealers risk
Price fluctuation

Information based
investors
Dealers has 2 important
services in Investors
Perspective
Possibility
to trade Maintenan
without the ce of Price
counterpar stability
ty to
emerge
Example:

Company’s shares are quoted by a

broker as bid for 49.8 Euro and 50.0
Euro. The bid- ask spread in percentage
is:
Spread = (50.0 Euro – 49.8 Euro)/ 50.0
Euro = 0.2 / 50.0=0.4%
Block trades
Sale or Purchase of a large number
of Securities
Large Transactions = Bid ask
Spread
2 Placing Order

Market order – an order to buy or

sell a security immediately at
the best obtainable price.

Limit order – an order to buy or

sell a security at a specified
price or better, lower for a buy
Specific Types of
Orders Include
Buy Limit Order (Stop Buy
Order)
Sell Limit Order (Stop Loss
Order)
Market-If-touched Order
 Types of Limit Order
Buy Limit Order (Stop Buy Order)
instructs a broker to purchase a
security when it hits a strike price that is
higher than the current spot price.
Sell Limit Order (Stop Loss Order)
an order placed with a broker to buy or
sell once the stock reaches a certain
price. A stop-loss is designed to limit an
investor's loss on a security position.
Market-If-touched Order

A buy MIT ("market if touched")

order price is placed below the current
price, while the sell MIT order price is
placed above the current price.
Example:
A broker is intending to by company X shares.
He can access the central limit order book directly
on the internet. The following information sell
orders (limit prices) and buy orders (ask prices) is
provided.
Sell orders Buy
orders
• Quantity Limits Limits
Quantity
• 1000 58 49
2000
 A broker has an order to buy
1000 shares and enter a market
order to buy those shares. A
market order will be executed
against a best matching order. At
what price will he buys the
shares?
other dimension of Order (Length of Tim

Fill or Kill Open

order order
or good-till-
is to be cancelled
cancelled order,
if it cannot be
remains in force
executed
until it is
immediately.
specifically
3 Margin Trading

An arrangement in which
an investor borrows
money or shares from a
broker to finance a
transaction
Broker call Rate – Interest rate
that Bank charges broker for
funds.
Stock exchange regulation set
Margin Requirement
Margin deposit – the amount of
cash or securities that must be
deposited as guarantee on a
futures position.

Stock exchange regulations

set initial margin
requirement
Example:
Assume an investor buys 200 shares
of a stock at 30 Euro per share for 6000
Euro of stock on 50% margin and the
maintenance margin is 30%. By
purchasing 6000 Euro of a stock on 50%
margin, the investor must put up 3000
Euro of cash (or other equity) and so
borrows 3000 Euro. The investor,
 Accordingly, if the stock price
declines 21,43 Euro the stock position
has a value of 4286 Euro (21,43 Euro
× 200 shares). With a loan of 3000
Euro, the equity in the account is 1286
Euro (4286 Euro – 3000 Euro), or 30%
of the account value (1286 Euro / 4286
Euro = 30%). If the price of the stock
decreases below 21,43 Euro, the
Maintenance margin – the
minimum margin that an
investor must keep on deposit in
a margin account at all times.
This is the minimum proportion
of the equity in the investor’s
margin account to the total
The
The return
return on stock
margin is Defined:
from the
purchased on

r =investment into
(SP – INV – L + D)/INV
securities is
SP = Selling Price of securities

influenced by the
INV = Initial investment
L = loan Payments ( Principal and Interest
proportion of the
Payments)
D = Dividend Payments
Example:

Assume investor decides to purchase

on margin company shares, which have
current market price of 60 Euro per
share. Annual dividend is 3 Euro per
share. The investor pays 30 Euro per
share in cash and borrows the
remaining amount from a broker at 10%
interest p.a. After a year the share is
The return for the investor is equal:

r = (90 – 30 – 33 + 3 ) / 30 = 100%

However, if the share price declines to 40

Euro and is sold for that price, the return
over a year will be equal to:

r = (40 – 30 – 33 + 3 ) / 30 = - 66,7%
 Investors borrows a
stock, sells the stock
and then buy the
stock back to return it
4
to the
Short Selling
lender.
Several indicators are used to
measure the short position on stock:

A degree of short positions.

Short interest ratio for specific
shares
Short interest ratio for the market
 Stock market regulations aim at ensuring
fair treatment of all investors in the market.
Regulated By :
National securities exchange
commissions
Individual stock exchanges

5 Stock trading
regulations
Equity premium puzzle

the persistent overpricing of

risk premium on stocks and
there is an arbitrage
opportunity.
Circuit breakers – automatic halts or
limitations in trading that are triggered upon
the attainment of certain stipulated price
moves.

The necessity of such restriction became

vivid during stock market crashes.
Three Threshold
level

Level 1 – 10% (30 to 60 minutes

Level 2 – 20% ( 1 to 2 hours)
Level 3 – 30% ( 1 Day)
50 point collar – provision that
prohibits computer assisted trading if
Dow Jones Industrial average index
rises or falls by 50 points.
250 point rule – provision that halts all
trading for one hour if Dow Jones
Industrial average index falls by 250
points in a day.
 Equity
Characteristics

Tanay, Ma. April

Equity Market Characteristi
Stock Indicators

Stock Market Indexes

Stock Market Indicators

Transaction Execution
Costs
Stock
1 indicators
Investors monitor stock price
quotations, provided in financial
websites and press.
Stock exchanges provide information

MARKET CAPITALIZATION
EARNINGS PER SHARE
P/E RATIO
DIVIDEND YIELD
MARKET CAPITALIZATION

refers to the total market value of a

company's outstanding shares of stock.
Commonly referred to as "market cap,"
 MARKET CAPITALIZATION

mber of Outstanding shares x Market price

Boxie has 25,000 authorized shares,
provided information by the PSE, with an
outstanding shares of 10,000 and a
market value of 50 per share.
What is the firm’s market capitalization?
Outstanding shares x Market value
per share = Market Cap

10,000 x 50 =
500,000
EARNINGS PER SHARE

• EPS shows how much money a

company makes for each share of its
stock.

• A higher EPS indicates more value

because investors will pay more for a
company with higher profits.
 EARNINGS PER SHARE

 
EPS
 
EPS

Compan Net Preferre Weighte

y Income d d
Dividen Commo
ds n
Shares
Ford 750M 0 25M
Land 500M 25M 35M
Company Net Income Preferred Weighted
Dividends Common
Shares
Ford 750M 0 25M
Land bank 500M 25M 35M

Basic EPS
Ford =
30/sha
Land bank =
re
13.57/s
hare
Price/Earnings Ratio

Used by investors and analysts to

determine the relative value of a company's
shares in its market value/price.

Sometimes called earnings multiplier

 P/E Ratio

 
P/E Ratio
 
P/E Ratio

Basic EPS
Ford =
30/sha
re
 
= 5
DIVIDEND YIELD

The dividend yield is the ratio of the annual

dividend compared to the current share price and
is expressed as a percentage.
 DIVIDEND YIELD

 
Dividend Yield
Suppose, Company Weather's
stock is trading at 500 Php and
pays annual dividends of 45
per share to its shareholders.
What is the dividend yield?
 
Dividend Yield

9%
 Stock market indexes are measures of
the price performance of stock
portfolios, which are formed to
represent a stock market as a whole or
a specific segment of the market, or sub
indexes.
Stock
2 market indexes
can be categorized by the w

the
the the method
method of
number of of
weighting averaging
stocks .
the stock
included;
prices;
Number of stocks

vary from a small number to

largest most liquid company
stocks to a wide portfolio of all
stocks traded on a particular
market.
Weighting of the stock prices

unweighted

value weighted

price weighted
UNWEIGHTED

all stocks equal

influence irrespective
of the sizes of the
companies.
In an equally-weighted index, all the
securities in the basket are, as it sounds,
weighted in equal amounts. For example,
Weigh
Stock Price Share
ting
A $3  2 20%
B $1  6 20%
C $7  0.86 20%
D $9  0.67 20%
E $10  0.60 20%
https://www.ftserussell.com/education-center/how-are-
Stock Price Share MARKET
Price x Weighti
A $3  2 CAP
Share ng
B $1  6 6 20%
C $7  0.86 6 20%
D $9  0.67 6.02 20%
E $10  0.60 6.03 20%
6 20%
30 100%
 An average of 10% rise of share
prices on one day is followed by an
average 30% rise of share prices the
next.
This gives a rise of 43% over the
two days:
1.1 x 1.3 = 1.43

Thus unweighted index is equal to 1.43

VALUE WEIGHTED

 takes into account the relative

importance or frequency of some
factors in a data set.
Market-capitalization weighted indexes (or
market cap- or cap-weighted indexes) weight their
securities by market value as measured by
Outstan Market Weighti
capitalization:
Security
Current
ding cap ng
Price
Shares 150 15%
A $3 50 50 5%
B $1 50 490 51%
C $7 70 180 19%
D $9 20 100 10%
E $10 10
Total
market cap 970 100%
https://www.ftserussell.com/education-center/how-are-
PRICE WEIGHTED

In a price-weighted stock index, each

company's stock is weighted by its
price per share, and the index is an
average of the share prices of all the
companies.
Price-weighted indexes aren’t particularly
common anymore. Still, one of the world’s most
widely tracked indexes – the Dow Jones
Industrial Average – uses price weighting,
Weightin so the
process is Security Price Share
worth understanding. g
A $3 10 10%
B $1 10 3%
C $7 10 23%
D $9 10 30%
E $10 10 33%
30
https://www.ftserussell.com/education-center/how-are-
Stock market indicators
3
In order to characterize and
compare national as well as
international stock markets, a
number of indicators are being
used
INDICATOR
S
1 Market
Size
2 Market
Liquidity
3 Concent
ration
4 Price
Volatility
MARKET SIZE
characterized by market capitalization.
Relative national market capitalizations
give indications of the importance of each
country to international investors.
MARKET LIQUIDITY

In liquid markets investors can be more

active and design various arbitrage
strategies. Market illiquidity tends to
imply higher transaction costs.
PRICE VOLATILITY

High volatility means that buyers in the

primary market are subject to a
considerable risk of losing money by
having to sell at a lower price in the
secondary market.
CTORS THAT AFFECT PRICE VOLATILITY

DEPTH OF THE BREADTH OF THE

MARKET MARKET
Based on the likely
appearance of new Reflects the
orders number
stimulated by any and diversity of the
movement traders
in price. in the market.
 CONCENTRATION

Also called degree of concentration can

be measured based on market capitalization
for specific stock exchanges.
 Expenses incurred to bring services
and costs for the completion of a buy
or sell order of a security.

Transaction Execution Cos

4
ing costs consist of two major compone

EXPLICIT COST IMPLICIT COST

represent such
are the direct indirect costs as the
costs of trading, price impact of the
such as broker trade and the
commissions, opportunity costs of
fees, and taxes. failing to execute in
a timely manner or
 Implicit trading costs inclu
TIMING COST
Timing costs occur when orders are on the trading desk of a
buy side company but are not yet released to the broker,
because the trader fears that the trade may swamp the
market.
OPPORTUNITY COST
This cost results from missed or only partially
completed trades.

IMPACT COST
transaction is related to the change in market price due to
supply and demand imbalances, caused by the trading
STOCK
VALUATION

Villanueva & Ponce

WHY DO WE
VALUE
STOCKS?
 Stock valuation is an important
tool that can help you make
informed decisions about trading.

To determine whether;
1.The stock is overvalued
2.The stock is undervalued
Ponce, Ronnel
TWO APPROACHES
OF ANALYSIS
Fundamental Technical
Analysis Analysis
 Fundamental Analysis
involves the following of a
company’s operations to
asses its economic
prospects.
ed in long-term investments.
(e.g. earnings)
 Technical Analysis a
forecasting method for
asset prices based solely on
information about
Oftentimes used the past
in short-term investm
prices.
FUNDAMENT
AL
ANALYSIS
 PRICE/EARNINGS METHOD
A method that applies the mean price
earnings (PE) ratio (based on expected
rather than recent earnings) of all
publicly traded competitors in the
respective industry to the firm’s
expected earnings for the next year.
Valuation per share = (Earnings
per share) × (Mean
Fundamental industry
Analysis PE
– P/E Method
ratio)
 Earnings per share
Earnings per share = Profit / total no.
of shares

A firm has a profit for the year of 10

million pesos. If there are 500,000
ordinary shares issued outstanding,
what is the earnings per share?
Fundamental Analysis – P/E Method
 PE Ratio
PE Ratio = Price / Earnings per
share

Assume that the market price

of the stock is 200 pesos. what
willFundamental
be the PE Analysis
Ratio to be used?
– P/E Method
 Consider that the firm is
expected to generate earnings of
25 pesos per share next year,
what is the valuation of the firm’s
share?

Fundamental Analysis – P/E Method

Limitations of PE method:

Price/earnings method has several

variations, which can result in
different valuations.
 DIVIDEND DISCOUNT
MODEL
The price of stock should reflect the
present value of stock’s future dividend
(Williams, 1931).

• Zero Growth Model

• Constant
Fundamental Growth
Analysis Model Discount Model
– Dividend
 •1.
  ZERO GROWTH MODEL

An approach to dividend valuation that

assumes a constant, no growing
dividend stream.

Fundamental Analysis – Dividend Discount Model

 This method can be used in the
valuation of preferred stock because
preferred stock typically provides its
holders with fixed annual dividends
over its assumed infinite life.

Fundamental Analysis – Dividend Discount Model

 A preferred share of stock pays
dividends of $1.80 per year, and
the required rate of return for the
stock is 8%, then what is its
present value?
 2. CONSTANT GROWTH MODEL
• 

A widely cited dividend valuation

approach that assumes that dividends
will grow at a constant rate, but a rate
that is less than the required return.

Constant rate of growth

Fundamental Analysis – Dividend Discount Model
 If a stock is expected to provide a
$4 dividend per share next year,
and the dividend has been growing
6% annually, then what will be the
value of the stock, assuming a
required rate of return of 12%?
Fundamental Analysis – Dividend Discount Model
 If a stock pays a $4 dividend
this year, and the dividend has
been growing 6% annually, then
what will be the value of the
stock, assuming a required rate
of return of 12%?
Fundamental Analysis – Dividend Discount Model
Limitations of Dividend Discount
Model

Errors can be made in estimating

dividend to be paid over the next year
or estimating the growth rate or the
required rate of return by investors
 ADJUSTED DIVIDEND
DISCOUNT MODEL
The value of the stock is equal to the present
value of the future dividends to be received
over the investment horizon plus the present
value of the forecasted price at which the stock
will be sold at the end of investment horizon.

PV of future dividends + PV of forecasted

price
Fundamental Analysis – Adjusted Dividend Discount Model
 PV of future dividends
• 

Value of common stock

Per share dividend expected at
end of year
Required return on stock
Fundamental Analysis – Adjusted Dividend Discount Model
 If the firm is expected to pay a
dividend of $5 per share over the next
four years, what will be the present
value if the required rate of return is
12%?

Fundamental Analysis – Adjusted Dividend Discount Model

 PV of forecasted price of stock
Step
•  1: Forecast the expected earnings
per share (EPS) in respect to investment
horizon.

Step 2: Apply the P/E method to

determine the future stock price.
Fundamental Analysis – Adjusted Dividend Discount Model
 •Step
  3: Compute the present value of
the future stock price

Fundamental Analysis – Adjusted Dividend Discount Model

 Assume that a firm currently has
earnings of $10 per share. Investors
expect that earnings per share will grow
by 2% annually and sell the stocks in
four years. Compute the price of stock
in four years if the PE ratio of the
industry is assumed to be 5.
Fundamental Analysis – Adjusted Dividend Discount Model
 The value of the stock is equal to the present
value of the future dividends to be received
over the investment horizon PLUS the present
value of the forecasted price at which the stock
will be sold at the end of investment horizon.

PV of future dividends + PV of forecasted

price

Fundamental Analysis – Adjusted Dividend Discount Model

Limitations of Adjusted DDM

The model may result to inaccurate

valuations if errors are made in
deriving the PV of future dividends
and forecasted price, as well in
calculating the required rate of return.
 PE Method Dividend Adjusted DDM
Discount Model
Dependent on the Dependent on Dependent on
Earnings Per Required rate of Required rate of
Share return return and the
mean PE ratio
Estimates the PE Estimates the PV Estimates the PV
ratio of expected of expected
future dividends future dividends
and the PV of
forecasted stock
prices
Inaccurate Inaccurate Inaccurate
valuation if errors valuation if errors valuation if errors
 Technical
analysis

Villanueva, Johnrev
WHAT IS TECHNICAL ANALYSIS?
• A forecasting method for asset
prices based solely on information
about past prices.
• Involves examination of past
information such as prices and
volume of trading which leads to
estimate future trends and
ASSUMPTIONS ON TECHNICAL
ANALYSIS
1. Securities’ market price is determined
solely by supply and demand.
2. Supply and demand are governed by both
rational and irrational factors.
3. Disregarding minor fluctuations, the
market as whole tend to move in trends.
4. Trends change due to shifts in supply
and demand, which can be determined by
 TECHNICAL ANALYSIS METHODS

Price Charts
 Presented using a vertical line.
 Vertical Line indicates certain
information about stocks.
 Measured at a certain time range.
 May provide a hint for the next
 TECHNICAL ANALYSIS METHODS

Trend Channels
 The channel wherein prices fluctuate over time.
 The channel has a certain trend.
 Trends can be bullish, bearish, or sideways.
 Trends are bound by support and resistance.
 Breaks in Trend Channels indicate a buy/sell signal.
 TECHNICAL ANALYSIS METHODS

Reversal Patterns
 Chart patterns created by price turns.
 Certain patterns give a possible predicted
outcome.
 The predicted outcome will be a factor for
investment decision-making.
 TECHNICAL ANALYSIS METHODS

Filter Rule
 Setting a percentage
decrease/increase of previous price
as a standard.
 Reaching the target decrease/increase
will be an buy/sell signal.
 TECHNICAL ANALYSIS METHODS

Short Interest Ratio

 Ratio of short sales to total trading.
 Rise in ratio may indicate a bearish
sentiment; a sell signal.
 Rise in ratio may also indicate a buy signal.
 TECHNICAL ANALYSIS METHODS

Relative Strength
 Ratio of stock price to a current market
index.
 Increase in ratio means a buy signal.
 Decrease in ratio means a sell signal.
 TECHNICAL ANALYSIS METHODS

Breadth of the Market

 Extent to which movement in a market
index is reflected in the price movement of
individual stocks.
 Market rise is viewed stronger, if prices
of large majority of stocks are rising.
 TECHNICAL ANALYSIS METHODS

Trading Volume
 Indication of strength of a trend.
 Higher trading volume of certain trend
indicates that it is less likely to
immediately bend.
 TECHNICAL ANALYSIS METHODS

Trin Statistic
 Ratio of average volume of stocks with
declining prices to average volume of
stocks with rising prices.
 Ratio above 1 shows a bearish market.
 Ratio below 1 shows a bullish market.
 TECHNICAL ANALYSIS METHODS

Mutual Fund Cash Holdings

 Increase indicates a bullish sentiment.
 Decrease indicates a bearish sentiment
 The volume of cash holdings reflects
the demand for stocks.
 TECHNICAL ANALYSIS METHODS

Put-call ratio
 Ratio of puts bought to calls bought
 Put options give rights to sell stocks at
specified price.
 Call options gives rights to buy stocks at
specified price.
 High ratio indicates a bearish market.
 TECHNICAL ANALYSIS METHODS

Dow theory
 Market is composed of 3 trends; primary,
secondary, and minor trends.
 Primary trends are reflected yearly.
 Secondary trends are reflected quarterly.
 Minor trends are reflected less than
quarterly.
 TECHNICAL ANALYSIS METHODS

Dow theory
Secondary movements in stock indices are used for


forecasting primary trend.

 Volume of trades confirm the trend.
 Trend must concur with the Dow Jones Industrial
Average
 Trend persists until a reversal occurs.
 TECHNICAL ANALYSIS METHODS

Elliott Wave Theory

 The market are moving cycles
 Cycles are composed of 8 waves;
 First 5 waves are motive waves.
 Next 3 waves are controlling waves.
 Yearly Cycles constitute a shorter period
cycles.
 &
Factors that
Affect Stock
Stock
Prices
Risk

Dumalo, Kathleen
Factors that affect
stock prices
Economic Factors

Market-Related Factors

Firm-Specific factors
 a. Economic
Factors
 Impact of economic growth

 Impact of interest rates

 Impact on the dollar’s

exchange rate value

 Impact on Economic
growth
Economic growth

Demand Places an
upward
Firm’s Cash Flows pressure on
firms value
Price of Stock
Exhibit 11.1 Stock Market trend Based
on the S&P 500 Index
Impact on Interest Rates

Required
Interest rate Stock price
rate of
return

Investors consider
purchasing a risky asset

Ris only if they expect to be

compensated with risk
premium for the risk
Impact of the Dollar’s Exchange Rate Value

Generally, US dollar
and economic growth
have direct Stock
realationship…. price

US Dollar & Economic

growth
 Impact of the Dollar’s Exchange
Rate Value
…but because of
Stoc
investor’s future
expectations: k
US Dollar price
Future
expectation
Investor’s prefer to
Stimulate adversely
affect purchase US stocks
when the dollar is
Economic growth weak and to sell
them when the dollar
b. Market-
related Factors
Investor January Effect
Sentiment

 Represents general  Investors prefer

mood of investors in the investing in riskier
stock market. small stocks at the
 It also involves future beginning of the year
expectations of and then. shifting to
investors. larger more stable
companies.
 Places and upward
pressure on small
stocks in January.
c. Firm-specific Factors Earnings
surprises
Earnings
Estimate
on Firm’s
Future
Change in Dividend Policy
Cash
flows
Dividend Firm’s Stock
expectation Price
Integration of Factors Affecting
Stock Prices

Exhibit 11.2 Framework for explaining changes in a firm’s

stock price over time.
STOCK
RISK
 Stock Risk
•  A stock risk reflects the uncertainty about future
returns.
• The RETURN on investing of a stock over a particular
period is measured as:
R=
Where:
R= Return
INV= Initial Investment
D= DIVIDEND
SP= Selling Price
EXAMPLE:
Mr. Abas bought 1 stock on KOKO TAH
Company for P100 and sold it for P150.
During the year, KOKO TAH Company
declared P4 dividend per share. What is
the RETURN on  the investment?
R=

Given: R= 0.54 or 54%

SP= 150
INV= 100
Mr. Villanueva bought 100 stocks on KOKOTAKU
Company for P150 per share. During the year, he
sold it for P160 per share. On December 31,
KOKOTAKU Company declared dividend of P2.50
per share. What is the return on investment?

Given:
R=
 

SP= 160 × 100

= 16,000
R= 0.0833 or
INV= 150 × 100
8.33%
= 15,000
D= 2.50 × 100
 On January 1,2019, Mr. Ponce bought 10%
of 1,000,000 shares of KOKOTA KAH MEE
Company for P4,000,000. He sold all of
his stocks on December 31,2019 for
P5,000,000. At the end of the year, the
entity declared  R=P12,000,000 annual
Given:
dividend. What is the return on
SP= 5,000,000
investment? R= 0.55 or 55%
INV= 4,000,000
D= 12,000,000 × 10%
= 1,200,000
 Mr. Dantes bought 20 stocks for P1,000 and sold
it for P800. During the year, KOTAANG TU EY
Company declared dividend of P30 per share.
What is the return on the investment?

Given: R=
 

SP= 800
INV= 1,000 R= 0.4 or 40%
D= 30 × 20 =
600
 Stock Risk

The main source of the uncertainty of

risk is the selling price of the stock.
Measurement of Stock Risk

Price Volatility

Beta

Value-at-Risk

Method
A. Volatility of a
Stock
A stock's volatility serves as a measure of
risk because it may indicate the degree of
uncertainty surrounding the stock's future
returns.
Also called total risk

because it reflects movement of stock

prices.
Exhibit 11.3 Implied volatility index for
U.S. stocks over time.
 B. Beta of a Stock

Measures the sensitivity of its returns.

It is used by many investors who

have diversified portfolio of stocks and
believe that the unsystematic risk of the
portfolio is therefore diversified away.
 C. Value-at-
Risk
It is a measurement that estimates
the largest expected loss to a particular
investment.
It focuses on the pessimistic side of
measuring risk.
 Market
Effi ciency

Obispo, Mae Abegail D.

 Market Efficiency
Refers to the degree to which
market prices reflect all available,
relevant information.
 If markets are efficient:
then all information is already
incorporated into prices, and so there is no
way to "beat" the market because there are
no undervalued or overvalued securities
available
The Efficient-Market
Hypothesis
The efficient-market hypothesis which is the basic theory
describing the behaviour of such a “perfect” market, specifically
states that
1. Securities are typically in equilibrium, which means that they are
fairly priced and that their expected returns equal their required
returns.

2. At any point in time, security prices fully reflect all public

information available about the firm and it’s securities, and these
prices react swiftly to new information.

3. Because the stocks are fully and fairly priced, investors need not
to waste their time trying to find and capitalize on mispriced
securities.
Economists refer to this excess compensation in
the stock markets as an ABNORMAL RETURN.

If a strategy is identified that can generate

abnormal returns, the attributes that lead
one to implement such a strategy is
referred to as a MARKET ANOMALY.
 Three Forms of Market
Efficiency
cording to Fama (1970), there are three levels of efficiency:

• Weak form of
market efficiency

• Semi-strong form of
market efficiency

• Strong Form of
market efficiency
 WEAK
W e a k FORM
f o rm
of market efficiency

The current price of securities is

fully affected by all the past
information in the market.

TEST
t e s t
 Tested by searching for
nonrandom pattern in security
prices.
• The “January Effect”
• The “Weekend Effect”
• The “Holiday Effect”
 A theory stating that all
Random current information is
walk reflected in current security
prices and that future price
theory
movement are random
because they are caused by
unexpected news.
Example
 SEMI
s e m I--STRONG
stro ng
FORM
f o refficiency
of market m

Stock prices are fully affected

by all past information and all
publicly available information.

TEST
t e s t
 Tested by assessing how
security returns adjust to
particular announcements.
STRONG
s t r o n g fFORM
o rm
of market efficiency

Reflection in the price of

securities by all publicly and
privately available
information.

TEST
t e s t
 Tests are very difficult since
the inside information used
is not publicly available.
Market reaction to new information
 Market Adjustment to New
Information
The process of market adjustment to new information
can be viewed in terms of rates of return.

Ex
R pe
ur ed

et ct
et ir
n

ur e d
R u
eq

n
is what an is the return
R

investor has an investor

to have to thinks she
invest in a will get in
specific the asset if
assets purchased.
The expected return can be
estimated by using a formula:

𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑏𝑒𝑛𝑒𝑓𝑖𝑡 𝑑𝑢𝑟𝑖𝑛𝑔𝑒𝑎𝑐h 𝑝𝑒𝑟𝑖𝑜𝑑

• 

^𝑘=
𝐶𝑢𝑟𝑟 𝑒𝑛𝑡 𝑝𝑟𝑖𝑐𝑒𝑜𝑓 𝑎𝑠𝑠𝑒𝑡
While the required return can be
estimated by beta and CAPM (Capital
Asset Pricing Model);

𝑘 =𝑅 𝐹 + [ 𝐵 ×( 𝑅𝑚 − 𝑅 𝑓 ) ]
 

Where:
 

= required return on asset

= risk-free rate of return
B = beta coefficient
= market return
Concept of Capital Asset Pricing
Model 𝐵=1.10
  𝑘=??
 

  = 8%

6%
6% Higher
Higher
  = 2% addition
addition risk
risk
al
al rate
rate Ex.
Ex. 10%
10% ????
????
Medium
Medium more
more
risk
risk volatile
volatile
“system
“system
No
No risk
risk Earns
Earns atic
atic risk”
risk” 2%
2% risk
risk
or
or “Risk
“Risk 2%
2% risk
risk free
free rate
rate
free”
free” free
free rate
rate
 ( 𝑘^ ≠ 𝑘 )
 
( k^ < k)
   
( 𝑘^ > 𝑘)

A market Investors
Investors
price would buy
sells the
adjustment the asset
asset
occurs
 
The common stock of Maghunda Industry is
currently selling for ₱50 per share, and market
participants expect it to generate benefits of ₱6.50 per
share during each coming period.
In addition, the risk-free rate, , is currently 7%; the
market rate return, is 12%; and the stock’s beta, B, is
1.20.
   To
To compute
compute for
for the
the expected
expected return:
return:
Given:
Given:
== 7%;
7%;
•   𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑𝑏𝑒𝑛𝑒𝑓𝑖𝑡 𝑑𝑢𝑟𝑖𝑛𝑔𝑒𝑎𝑐h 𝑝𝑒𝑟𝑖𝑜𝑑
^𝑘= ₱ 6.50
== 1.20.
1.20.    
== 12%
12% ^
𝑘=
== ₱6.50
₱6.50
𝐶𝑢𝑟𝑟 𝑒𝑛𝑡 𝑝𝑟𝑖𝑐𝑒𝑜𝑓 𝑎𝑠𝑠𝑒𝑡 ₱ 50.00
== ₱50
₱50
To
To compute
compute for
for the
the required
required return:
return:

 
𝑘 =𝑅 𝐹 + [ 𝐵 ×( 𝑅𝑚 − 𝑅 𝑓 ) ]

𝑘 =7 % + [ 1.20×(12 % − 7 %) ]
 

 
 Assume that a press To
To compute
compute for
for the
the required
required return:
return:
release announces
that a major product
liability suit has 𝑘 =𝑅 𝐹 + [ 𝐵 ×( 𝑅𝑚 − 𝑅 𝑓 ) ]
 
been filed against
Maghunda
Company. As a
result, investors 𝑘 =7 % + [ 1.40×(12 % − 7 %) ]
 

immediately adjust
their risk
assessment  
upward, raising the
beta from 1.20 to
1.40.
To
To compute
compute for
for the
the expected
expected return:
return:

•   𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑏𝑒𝑛𝑒𝑓𝑖𝑡 𝑑𝑢𝑟𝑖𝑛𝑔𝑒𝑎𝑐h 𝑝𝑒𝑟𝑖𝑜𝑑

^𝑘= ₱ 6.50
   
^
𝑘=
𝐶𝑢𝑟𝑟 𝑒𝑛𝑡 𝑝𝑟𝑖𝑐𝑒𝑜𝑓 𝑎𝑠𝑠𝑒𝑡 ₱ 46.43
Suppose index is based on just three stocks whose
prices and numbers of shares issued are the
following.
Stock A Price 50Euro, total 10 million shares
Stock B Price 100Euro, total 10 million
shares
The changes relate to just one day (so no
Stock C Price 200Euro, total 5 million shares
compounding over time is involved). Supposed
(a) that stock A rises in price by 15% during the
day while the other two prices remain unchanged,
and
(b) that stock C undergoes a 15% price rise while
Before the price rise, the index equals 100.
In the event of a 15% rise in the price of A, the new
index will be (using arithmetic means):
(New value / Old value) x 100 =
= (1, 15 + 1 + 1) / (1 +1 +1) x 100 = 1,05 x
100 =105
If the price of C rises by 15%, the new index will be:
(New value / Old value) x 100 =
= (1 + 1 + 1,15) / (1 +1 +1) x 100 = 1,05 x
100 =105