Case Summary of The september 11 terrorist attack on Stock market

1. Background: The September 11 terrorist attack, the Enron Scandal both negatively hampered
on the U.S. stock market and which can be explained with the help of Gordon Growth model.
And I completely agree with the Gordon Growth Model of pricing of value of stock and by that
both affected negatively on the stock market.
Gordon Growth Model
The generalized dividend valuation model requires that we compute the presentvalue of an
infinite stream of dividends, a process that could be difficult, to say theleast. Therefore,
simplified models have been developed to make the calculations easier. One such model is the
Gordon growth model, which assumes constant dividendgrowth.
The Gordon Growth Model, also known as the dividend discount model (DDM), is a method for
calculating the intrinsic value of a stock, exclusive of current market conditions. The model
equates this value to the present value of a stock's future dividends.
This model is useful for finding the value of stock, given a few assumptions:
1. Dividends are assumed to continue growing at a constant rate forever.
2. The growth rate is assumed to be less than the required return on equity, ke.
The stable model:
Value of stock (P0) = D1/ (k - g)
Where:
D1 = next year's expected annual dividend per share
k = the investor's discount rate or required rate of return, which can be estimated using the
Capital Asset Pricing Model or the Dividend Growth Model (see Cost of Equity)
g = the expected dividend growth rate (note that this is assumed to be constant)
The September 11 Terrorist Attacks and the stock market:
The September 11 terrorist attacks raised the possibility thatterrorism against the United States
would paralyze the country.These fears led to a downward revision of the growth prospectsfor
U.S. companies, thus lowering the dividends growth rate g inthe Gordon model and led to a
decline in P0.Increased uncertainty for the U.S. economy would also raise therequired return on
investment in equity. A higher k leads to anincrease in the denominator in equation 4 and a
decline in P0.The Fed lent $45 billion on Sept 11, 2001 to banks and thrifts. Subsequently, the
U.S. successes against the Taliban and theabsence of further terrorist attacks reduced market
fears anduncertainty, causing g to recover and k to fall, leading to recovery in P0 and a rebound
in the stock market.
When the D1 decreases of the companies for upcoming year then obviously the P0 would
decrease. The D1 is decreased because the terrorist attack may paralyze the U.S. economy and
that will also impact on the financial status of the companies. This will decline the D1 of U.S.
companies by which P0 of the stock decrease.

2. But theinvestor's required rate of return will remain same by which the ke will increase by which
also the P0 of company will decrease and which will impact on the stock index.
Due to terrorist attack, the companies can’t make high growth rate because that affected in the
U.S. economy, by decreasing in the g, the P0 will decrease with the help of Gordon growth
model.
In conclusion, we can say that the impact on economy of country, D1, ke and g will change in
such a way that by which the stock market negatively affected.
The Enron Scandal and the stock market:
The Enron Scandal disclosures that many companies had overstated their earnings caused many
investors to doubt theformerly rosy forecast of earnings and dividend growth
forcorporations.This result in revising g downward, and k upward, because ofincreasing
uncertainty about the quality of accounting information, lead to an increase in the denominator in
theGordon Equation, thereby lowering P0 for many companies andhence the overall stock
market.
Again, with the Gordon growth model, when there is Enron scandal, the investors thinks that
most of the companies may overstated their actual profit by which the D1 of the company will
decrease in the eyes of the investors, which will directly impact on the stock price of the
companies.
But the expected return of the investors from the companies will be same as of previous years,
and which leads to increase in the ke of the companies, which inversely effect on the P0 of the
companies by Gordon model and there is decrease in the P0 of the company.
And again, the growth of the companies g, will decrease because of the low investment by the
investors and due to Enron scandal, there will be less growth by the companies and which will
help to decrease the g of company and again according to Gordon model, that will help to
decrease the P0 of the companies and which ultimately decrease the stock index.
In conclusion, it is proved that if there is any misrepresentation on the information of the
company, which leads to decrease in the stock index because of the behaviour of the investors.
Conclusion for Both Cases
At last, we can say that the expectations are a powerful tool foranalyzing behavior. But to
establish that it is in reality a useful tool, we must comparethe outcomes predicted by the
information with empirical evidence. Although the evidenceis mixed and controversial, it
indicates that for many purposes, the rationalexpectations is a good starting point for analyzing
expectations.Expectations will be identical to optimal forecasts using all available information.
Ram Krishna Tiwari
Roll no. 23; MFC, SOMTU