1. Week 4 Lecture
Chapters 7 and 8

2. Chapter 7
• Stock (Equity)-Characteristics and
Valuation
2. Types of different stocks and
characteristics
3. How to use different valuation techniques

3. STOCK
• Types
– Preferred Stock (hybrid)
• Has par, dividend similar to interest pymt, but no maturity
• Skipping dividend doesn’t lead to bankruptcy
• Cumulative dividends and priority over common stock
• Usually no voting rights but is available for conversion
– Common Stock
• Owners of firm, sometimes get dividends, may have par value, but
no maturity
• Last in the food chain to be paid in the event of liquidation
• Has voting rights and preemptive rights
• Other types: Classified, Founders, Closely held

4. International/Foreign
• ADR
– Certificates not foreign stock that represent
ownership
• Foreign Equity
– Not as much protection of investor rights
– AKA Euro Stock or “Yankee stock”

5. Valuation
• See page 272 for terms and definitions
Stock Value (expected dividends)=
Sum of Dividends (Dt) in each Time (t)
(1 + rs)^t

6. Valuation
Zero Growth (perpetuity)Valuation=
D
rs
Normal Growth (Gordon) Valuation=
D1
rs-g
Growth in dividends occurs from EPS growth

7. Valuation
• Using P/E Ratios (payback period)
– Compared to industry average
• Lower-less promising
• Higher-more promising
• Using EVA=
EBIT (1-T)-[%cost funds x invested capital]
Please also study the chapter summary starting on
page 291

8. Chapter 8
• Risk and Rates of Return
2. Define risk and probability and know the
difference
3. How are they measured
4. What is Beta?

9. RISK
• Hazard, peril, exposure to loss or injury
• Multiple outcome possible
• Investment Risk
– Variability of returns

10. PROBABILITY
• The chance said risk will occur
• Measurable
• Must add up to 100%
• Expected rate of return is a type of
probability

11. Standard Deviation
(oh yes you thought you were done with this)
• Measures stand-alone risk (sigma)

12. More…
• Coefficient of Variation =Risk/Return
• Risk Aversion and required returns
– Risk adverse-choose less risky investments
– Risk premium=higher returns-lower returns
or what you are giving up

13. PORFOLIO RISK
• Diversification is the key to lowering risk
– Expected return (weighted average)
– Different from risk of individual securities
• Firm Specific vs Market Risk
– Market is based on all stocks in the market
– Firm (lawsuits, strikes, loss of key personnel)

14. BETA
• Measures stocks sensitivity to market
• Know what the different numbers indicate

15. CAPM
• For a specific beta, what rate of return do
investors expect?
• Something to ponder
– “Past performance is not an indicator or future
value”

16. RISK
• Please review additional risk located in
table 8-5 on page 339
– Systematic, unsystematic, and combined